How redundant is your portfolio?

Towards the end of my mutual fund days, I looked at the hodge-podge of funds I owned and noticed that they tended to own the same stock. In other words, I wasn’t mitigating my risk properly since, even if the mutual funds had different names and purposes, they held enough of the same stocks that, if these baskets of stocks performed poorly, it tended to result in most of my mutual funds also performing poorly. Hindsight being 20/20, it is easy to see why this happened. As many other bloggers have pointed out, many large mutual funds tend to own the same stocks as the major equity or bond benchmarks (another reason why investing in mutual funds may not be the most prudent product one can purchase given you are paying more fees than an exchange traded fund charges for bascially holding the same basket of stocks).

A pillar of constructing a good portfolio avoids a great deal of redundancies. Redundancies can take several forms. As I indicated, there could be product redundancy in that the products you purchase hold the same type of stocks or bonds. The frequency of this redundancy tends to be greater if you are purchase a lot of different types of mutual funds. However, as the exchange traded funds industry matures, and begins to offer new and trendy ETF’s, the tendancy to inadvertently create portfolio redundancies also increases. Take, for example, the new series of infrastructure ETF’s being introduced to the market. Many of these ETF’s track pipeline, utilties and railway stocks which are also found in broader based blue-chip equity ETF’s. By purchasing both equity and infrastructure ETF’s, you could end up tracking the same stocks.

The other redundancy is simply owing too many stocks in the same industry if you are an active investor. I am guilty of this crime being a bank stock junkie. Ideally (and I wish I followed my own advice), one should only hold the leader in each industry since it tends, over time, to be a proxy for the industry. For example, history shows that over an extended period of time, the performance of the big 5 Canadian Bank stocks vary by approximately 1% from the top performer to the bottom. Thus, picking say RBC over CIBC, is more of an exercise in intellectual curiosity than obtaining any performance edge over a long enough period of time.

Thus, it is not only prudent to check your allocation between cash, bonds and equity but to assess what you hold inside bonds and equity to ensure there is no redundancies.