The Role of Diversification in Risk Management

Diversification is a very specific thing that you can measure. It is the extent to which your portfolio's volatility (risk) is LESS than the sum of each position's volatility. It tells you how much "free-lunch" you're getting, which translates to not only lower risk, but into improved returns. You want the Diversification Ratio to be as high as possible. Because without diversification, the only other way of creating value is by stock picking or market timing. And good luck with that. To maximize the Diversification Ratio, you will want to diversify both types of risk: - Company Specific Risk - Market (Systematic) Risk Company specific risk is easy to diversify with index funds. For example, the std. deviation of the S&P500 is around 16%, while the weighted average sum of the std. deviations of the stocks in the index is around 32%. So depending on your measurement period, you're getting about a 50% reduction in risk without any reduction in return! But don't stop there. You still have the risk of the stock market itself to diversify. You could use AGG bonds like everybody else, but you might as well be holding cash. AGG bonds barely improve the Diversification Ratio at all. But if you used liquid alts to diversify the systematic risk of equities instead, you can improve the Diversification Ratio by another 40-50%. Take a look at your portfolio. I bet if you measured your Diversification Ratio, you would be diversified against company specific risk but have near zero diversification against market/systematic risk. This is why you're not protecting your client's to the downside, and why your portfolio has zero alpha vs the S&P500. Diversifying the systematic risk of equities is the biggest opportunity for adding value (alpha) that you are leaving on the table. It is so simple and intuitive. Yet advisors are still focused on trying to add value through stock picking and/or timing their stock exposure.

Achieved 50% less risk in my portfolio in just one year. Here’s how I did it: Most investors think they're diversified. They're not. I see the same mistake everywhere I look. The real estate agent with 3 rental properties. All in the same neighborhood. All bought the same year. The tech worker with their entire 401k in company stock. The entrepreneur who only invests locally. Here's what real diversification actually looks like. **The Single-Basket Problem** Picture this scenario: You own 3 rental properties worth $600,000. Same street. Same market. Same risk. The local factory closes. Unemployment spikes. All three properties lose 30% of their value overnight. Your entire real estate portfolio just got crushed. This isn't diversification. It's concentration disguised as diversification. **Why Most People Get This Wrong** We invest in what we know. We buy where we live. We stick with what's comfortable. But comfort is the enemy of true wealth building. Real diversification means spreading risk across: Different geographic markets Multiple asset classes Various time periods Different management teams Multiple economic drivers **The Syndication Advantage** When you invest in a multifamily syndication, you get instant diversification. One $50,000 investment gives you exposure to: 200+ different tenants Multiple income streams Professional management Diversified local economy Compare that to buying one rental property. Same investment amount. Exponentially less risk. **Real Numbers, Real Difference** Investor A: $200,000 in one rental property 1 property 1 tenant at a time 1 local market 100% concentration risk Investor B: $200,000 across 4 syndications 776 total units 4 different markets Multiple management teams Diversified risk profile Which investor sleeps better at night? **Your Portfolio Reality Check** Ask yourself these questions: What percentage of your wealth is tied to your local market? If your industry had a downturn, would both your job AND investments suffer? Are you comfortable betting your financial future on one geographic area? **The Texas Diversification Strategy** Smart investors spread across multiple Texas markets: Austin: Tech-driven growth Dallas: Corporate headquarters hub San Antonio: Military and healthcare stable Houston: Energy and port commerce Different economic drivers. Different risk profiles. Better sleep at night. **Your Next Move** Look at your current portfolio concentration. Identify your biggest risks. Start building true diversification. Success isn't about finding the perfect investment. It's about building a portfolio that survives any storm. **What's your biggest concentration risk right now?** **PS:** What's holding you back from diversifying beyond your local market? I'd love to hear your biggest challenge in the comments.

📊LP Strategy – Index Approach to Startup Investing → 6 Takeaways Months ago, Zachary and I wrote about the Index Approach to startup investing for LPs. According to a Harvard University study of 2,000 venture backed startups, it's estimated that: - 75% failed to produce any returns to investors.  - Only 1% - 2.5% of venture backed companies ever become unicorns (worth over $1B). According to a study by CB Insights: - only 0.07% of venture-backed startups have reached decacorn status - i.e. only 1 out of every 1,400 venture-backed startups will become a $10B business. The most obvious takeaway is that picking unicorns and decacorns is extremely hard, and odds are that any single startup investment will return you near zero capital backed. By creating a diversified portfolio of high risk investments, early stage VCs more or less accept that the majority of their portfolio companies will fail or return 0-1x capital back, but the few that make it will become massive winners, providing outlier returns of 100-500x+ invested capital and return the fund, potentially many times over. This is crucial to understand as an LP when you think about allocating into early-stage startups. You can check out our full post (link in comments) but our 6 takeaways to conclude are as follows: 1) While investing in startups can be lucrative, your diversification strategy will play a meaningful role in your returns. 2) While a fund GP may take a different (or more concentrated strategy) because of their access to management, data, perceived competitive advantages, etc. the data suggests as a whole LPs are not served best with this approach, and we agree. 3) If you decide to create a concentrated portfolio, you can create an outlier portfolio, but this strategy for most LPs will result to below market returns. 4) Create a financial plan to determine exactly how much you can afford to invest in startups (using 1-5% of worth as a guideline, but ask your financial advisor). Divide your pooled capital by a very large number (well over 50) to drive you closer to market returns, as it will increase your chance of getting that portfolio outlier that can return your entire invested capital multiple times over. 5) Alternatively, if you want exposure to the asset class in a diversified way but don’t want to put in the effort, a good option is to invest in Rolling Fund from a GP you trust. 6) As a whole, getting small exposure to this asset class has the ability to provide LPs with strong return, but it is a high-risk/high-reward asset class with returns uncorrelated to returns from other asset classes. Return potential for venture is among the highest of all asset classes. -- I write about VC Syndicates. Powered by Sydecar, Last Money In Media is the most actionable venture capital newsletter.