Insights – Convex Returns: The Key to a Diversified Portfolio

Diversification is the fundamental feature of portfolio management and asset allocation, but is there more to it than just measuring correlation and calling it a day?

In this article, we look more closely into the concept of convex return relationships between assets, ensuring that diversifiers perform and thus protect against the drawdowns of other assets in the portfolio.

Convex diversification profiles play an important role in the All Seasons Portfolio for making drawdowns shallower and creating opportunities for earning rebalancing premiums.

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Insights – Has gold lost its status as an inflation hedge?

In 2022, inflation made its presence clear and undeniable. While it can be argued whether we experienced an inflation "surprise", investors were reminded of the importance of inflation hedges in their portfolios as stocks and bonds suffered.

Gold is one such inflation hedge, but he narrative in financial media has bashed its capabilities of protecting against inflation in 2022, as the gold price ($) was barely flat for the year.

In today's article, we will be reviewing whether gold has lost its appeal as an inflation hedge, or if it rather needs to be viewed from a different angle.

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Insights – The Case for Gold in a Diversified Portfolio

Gold is a popular investment due to its ability to hedge against inflation, low correlation with the stock market, and its relationship with real interest rates. Using modern portfolio theory and the efficient frontier, investors can find the optimal allocation to gold in their portfolios that balances expected returns and risk. However, the optimal level of gold allocation will depend on an investor's specific investment objectives, risk tolerance, and financial situation. Therefore, adding gold to a well-diversified portfolio can improve its risk-return characteristics, particularly during periods of market stress.

In this article, we explore gold as an investment and inflation hedge, and briefly touch on how it fared in the inflationary year of 2022. We further look at the current case for gold in terms of real interest rates, the M2 money supply, and discuss how the gold price performs relative to also other currencies than just the US dollar.

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eToro Post – How Strategic Rebalancing Helped Avoid a -35% Loss in Long Treasury Bonds

Since I joined eToro in April last year, I have been sharing insights and observations about investing with risk balanced strategies such as the All Seasons Portfolio (“ASP”) strategy I run here. As eToro is a social trading platform, I from time to time share content in my eToro feed, which I then share on the blog in posts like this.

As part of my All Seasons Portfolio, the asset classes have a set aimed allocation, which is based on their historical volatility and correlations and biases to different economic regimes. For rebalancing the portfolio, I apply rebalancing spans that allow assets to deviate from the aimed allocation with +/- 20%, unless it is in a trend.

Such rebalancing trigger occurred in March 2022 for Long-Term Treasury Bonds, as its weight had fallen by more than 20%, but as it was in a clear negative trend, rebalancing was postponed until May 2022.

By waiting with the rebalancing, I managed to avoid a loss of more than 35% on the position I would have taken in March (or -2.5% on a portfolio level).

In this post, we describe in a bit more detail the benefits of applying such strategic rebalancing rules.

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eToro Post – Different Types of Inflation and Assets That Hedge Against Each

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Surely you have not missed the talks about inflation the past year. Even from the Fed and Yellen, the sentiment about inflation has changed from “not a problem” to “transitory” to “longer than first expected” and now to “good for the economy”.

While the price of risk assets, such as stocks, may also inflate due to the rise in inflation, they are not rising as much in real terms.

Rising inflation, and especially inflation that is higher than expected, is harmful to most common portfolios that comprise of stocks, or a combination of the two like the 60/40 Portfolio. Both stock and bonds are assets that perform well in times of low or decreasing inflation, and will lag in times when inflation rises.

It is thus vital to have a portfolio which also includes inflation hedges to mitigate the risk of unexpected inflation prints.

In this post, we will be looking at different types of inflation - as inflation can manifest in different ways - and how you can protect your wealth against each of them with different assets.

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eToro Post – Prediction vs. Preparation

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Is a good investment outcome always a sign of a great investment decision?

Intuitively, one could believe so, but more often than you might believe, that is actually not the case.

The past decade has favored stocks massively, meaning that investors who ignored diversified investment strategies and who applied poor risk management, have actually benefitted, while prudent investors have seen their neighbors get richer on meme stocks, cryptos and ARKK ETFs.

But are all these stock investors geniuses for achieving such a great outcome? Hardly. Such a belief among these investors – that they are superior investors – is just a form of outcome bias or “resulting” as described by Annie Dike in her book “Thinking In Bets”.

In short, this means that not all decisions with good results are necessarily good decisions.

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