Different investors will prefer different strategies and implementation options based on risk tolerances, capacity to implement illiquid investments, ability to access the top managers, and available resources for managing a complex portfolio. The traditional portfolio shown in Exhibit 4 is a fairly typical structure designed to capture diversified beta through long-only managers—it is focused solely on public equity exposure, and although it allocates 20% of its total to both a regional and small-cap manager, the objective is clearly to capture emerging markets beta.
—Mary Jo Palermo, Eric Winig, Greg Moessing: Highlights from The Case for Diversified Emerging Markets Exposure, Cambridge Associates, 2011.
Diworsification: The term was coined by the legendary investor Peter Lynch in his book, One Up on Wall Street, where he suggested that a business that diversifies too widely risks destroying their original business because management time, energy and resources are diverted from the original investment.
What’s the opposite of “implement?” Explement? Never mind. The objective is to “capture emerging market beta.”
The above Cambridge Associates paragraph was written by well-meaning associates who are no doubt Level-something in the CFA Institute curricula. The paragraph is part of less than 10 pages of hedged language on how emerging markets investment can benefit a “carefully balanced portfolio.” (My quotes.)
I don’t need to see “Exhibit 4″ to know that institutional calming of cyclical and volatile markets is nothing more than fee justification wrapped around modern (medieval?) portfolio theory that underestimates panic over “occasional” rapid price moves.
Emerging markets are great while the getting is good and then, without fail, go the opposite way. I will leave it to consultants to consult on the structural >127 basis points of alpha to be picked up by diversifying away portfolio beta given cyclical vega.
I’m worried about the gamma and the gamma is now. (See USD-ZAR for a representative canary in the diamond mine.)
Read up on the Greeks, or simplify and consider Mr. Lynch’s classic lesson on diworsifying.
June 2013 is all-too familiar. At some unknowable point, they will exit the EM theater out onto the great Illiquid Boulevard. Peter Lynch won’t be there to hold their hand. Discuss.