Kevin Barr, Head of SEI’s Investment Management Unit, and Jim Smigiel, SEI’s Chief Investment Officer, kick off a seven-part video series about asset allocation. Their first discussion centers on SEI’s longstanding belief that well-diversified portfolios can maximize investors’ chances of achieving their financial objectives

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Transcript

Kevin Barr: Hi, I'm Kevin Barr, Head of SEI's Investment Management Unit. At SEI, we have a long-standing belief that well-diversified portfolios can maximize investor chances of achieving their financial objectives. To provide greater transparency and insight into why we maintain this view, I've asked Jim Smigiel, SEI's Chief Investment Officer to join me today.

Kevin Barr: Thank you for joining me today, Jim. To start what will be the first of a seven-part series about asset allocation, I'd like to talk about performance. For more than a decade now, the S&P 500 has outperformed diversified equity portfolios. Why should investors believe that diversification is still a valid strategy?

Jim Smigiel: Thanks, Kevin. And you are correct, a diversified portfolio by its very nature will not outperform the best performing asset class in any given time period, just like a diversified equity portfolio will not outperform the best performing stock. The decade-long bull market that ended in March of 2020, was concentrated in one region and in one sector. The largest companies in the US outperformed small cap and international stocks by significant margins over the last 10 years, over 200% cumulatively based on the performance of mega cap technology names.

Jim Smigiel: This type of concentrated performance and concentrated leadership can and has happened in the past, but we would not suggest that this justifies taking on concentrated risk in any single stock or any single sector or any single asset class. Predicting the future is hard, if not impossible. And we believe that a diversified portfolio serves investors well by positioning them for a range of possible outcomes, rather than a small subset that is only relying on the performance of any one position or sector.

Jim Smigiel: This chart illustrates that point by highlighting the calendar year performance of sectors in the S&P 500. Investors may be surprised to see the diverse leadership over these 12 month periods. The same is true for broader asset classes, as we can see in this next chart. The question investors should be asking isn't about why a diversified portfolio doesn't outperform the best performing asset class in any given year, but whether they believe that they can correctly guess which asset class will do best each year and then perfectly time their entries and exits to capture that performance. As far as we know, no one has yet been able to do that on a consistent basis, so we remain very comfortable with a diversified approach.

Jim Smigiel: Essentially, what we're saying is that we don't expect a diversified portfolio to be the top performer in any given time period. But what we are saying, however, is that we remain confident that a diversified approach can be a prudent one for investors given the uncertainty that we all face.

Kevin Barr: Well, when most people hear the words diversified portfolio, they think about having a mix of stocks and bonds, something like the classic 60/40 equity-to-fixed income portfolio, right?

Jim Smigiel: That is right. And it's also completely wrong. The ubiquitous balanced portfolio that we're all well aware of, this kind of 60/40 with 60% of your capital being invested in stocks and 40% of your assets being invested in bonds, is actually overwhelmingly dominated by equity risk. If you think about it, think about the fact that stocks are genuinely three to five times riskier than investment-grade bonds. So even this supposed balanced portfolio, the 60/40, this portfolio delivers more than 90% of its risks from the stocks.

Kevin Barr: So when you refer to a diversified portfolio, can you explain exactly what you mean?

Jim Smigiel: Sure. We try to minimize the uncertainty surrounding investment outcomes through diversification, which we believe is the most powerful tool an investor can use in this pursuit. So diversification involves distributing a portfolio's risk across a variety of asset classes and risk exposures in order to reduce the reliance on any one source of return.

Jim Smigiel: So forecasting outcomes in the capital markets is a notoriously difficult task. If it's not performed conscientiously and with an appreciation for the fact that one's forecast, including ours will inevitably be wrong, forecasting can expose investors to undue risk without compensation. So by recognizing this, by understanding that we're in the prediction business, by insulating portfolios against these uncertainties inherent in our predictions, we seek to build portfolios that are well-prepared to help deliver financial success for investors across a wide range of economic and market scenarios.

Jim Smigiel: Looking at our portfolio construction methodology against the standard 60/40 supposedly diversified portfolio, that can really highlight some of the key differences. So rather than allocating to a broad stock market benchmark and a broad bond benchmark, for example, we seek to provide diversification within stock and bond allocations to include a broad range of exposures within even each of those asset classes. So not just exposure to stocks, but exposure to large cap stocks and mid cap stocks and small cap stocks, emerging market stocks, and even low volatility stocks.

Kevin Barr: Well, Jim, what if I'm an investor with a very long time horizon, say more than 30 years, or in the case of a pension, endowment or foundation, perhaps forever, do I still need to be diversified?

Jim Smigiel: It's a good point. It's common question. And risk doesn't go away as your time horizon lengthens. That's a bit of a misnomer. It actually grows. So as your time horizon increases, your path dependency and therefore the potential for bad outcomes actually grows along with it. We see numerous periods of time in which equities have lost more than a third of their purchasing power over periods, decades or longer. So regardless of the time horizon diversification can offer higher returns at any given level of risk or less risk at any given level of return. This can give investors more confidence in achieving their financial goals.

Kevin Barr: Thanks,

Jim. The next time we can get together, we'll continue our discussion with a closer look at how and why we implement reduced reliance on concentrated equity risk.

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Legal Note

Important Information

The information contained herein is for general and educational information purposes only and is not intended to constitute legal, tax, accounting, securities, research or investment advice regarding the Strategies or any security in particular, nor an opinion regarding the appropriateness of any investment. This information should not be construed as a recommendation to purchase or sell a security, derivative or futures contract. You should not act or rely on the information contained herein without obtaining specific legal, tax, accounting and investment advice from an investment professional. This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results.

Diversification does not ensure a profit or guarantee against a loss.

There are risks involved with investing, including loss of principal. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from difference in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Narrowly focused investments and smaller companies typically exhibit higher volatility. Bonds and bond funds will decrease in value as interest rates rise.

High yield bonds involve greater risks of default or downgrade and are more volatile than investment grade securities, due to the speculative nature of their investments.

Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of SEI Investments Company (SEI).

Index Definitions

  • Bloomberg Barclays 1-5 Year US TIPS Index (USD): The Bloomberg Barclays 1-5 Year U.S. TIPS Index measures the performance of inflation-protected public obligations of the U.S. Treasury that have a remaining maturity of one to five years.
  • Bloomberg Barclays Long US Government/Credit Index (USD): The Bloomberg Barclays Long US Government/Credit Index measures the investment return of all medium and larger public issues of U.S. Treasury, agency, investment-grade corporate and investment-grade international dollar-denominated bonds with maturities longer than 10 years. The average maturity is approximately 20 years.
  • Bloomberg Commodity Total Return Index (USD): The Bloomberg Commodity Total Return index is composed of futures contracts and reflects the returns on a fully collateralized investment in the BCOM. This combines the returns of the BCOM with the returns on cash collateral invested in 13 week (3 Month) U.S. Treasury Bills.
  • Bloomberg Barclays US Aggregate Bond Index (USD): The Bloomberg Barclays U.S. Aggregate Bond Index is a benchmark index composed of U.S. securities in Treasury, government-related, corporate and securitized sectors. It includes securities that are of investment-grade quality or better, have at least one year to maturity and have an outstanding par value of at least $250 million.
  • ICE BofA 1-5 Year US Treasury Index: The ICE BofA 1-5 US Year Treasury Index is an unmanaged index that tracks the performance of the direct sovereign debt of the U.S. Government having a maturity of at least one year and less than five years.
  • ICE BofA USD 3-Mon Deposit Offered Rate Constant Maturity: The ICE BofA USD 3-Month LIBOR Constant Maturity Index is based on the assumed purchase of a synthetic instrument having three months to maturity and with a coupon equal to the closing quote for 3-month LIBOR. That issue is sold the following day (priced at a yield equal to the current day closing 3-month LIBOR rate) and is rolled into a new 3-month instrument. The index, therefore, will always have a constant maturity equal to exactly three months.
  • ICE BofA US High Yield Constrained Index: The ICE BofA US High Yield Constrained Index measures the performance of high yield bonds.
  • JP Morgan GBI Emerging Markets Global Diversified: The J.P. Morgan EMBI Index is a total return, unmanaged trade-weighted index for U.S. dollar-denominated emerging-market bonds, including sovereign debt, quasi-sovereign debt, Brady bonds, loans and Eurobonds.
  • JP Morgan EMBI Global Diversified Index: The JP Morgan EMBI Global Diversified Index tracks the performance of external debt instruments (including U.S.-dollar-denominated and other external-currency-denominated Brady bonds, loans, eurobonds and local-market instruments) in emerging markets.
  • MSCI Emerging Markets Index (Net): The MSCI Emerging Markets Index is a free float-adjusted market-capitalization-weighted index designed to measure the performance of global emerging-market equities.
  • MSCI EAFE Index (Net): The MSCI EAFE Index is an unmanaged, market-capitalization-weighted equity index that represents the developed world outside North America.
  • Russell 2000 Index: The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represents approximately 8% of the total market capitalization of the Russell 3000 Index.
  • S&P 500 Index: The Standard & Poor's (S&P) 500 Index is an unmanaged, market-weighted index that consists of 500 of the largest publicly-traded U.S. companies and is considered representative of the broad U.S. stock market.