As the public markets open up to facilitate new opportunities for personal investors to diversify their holdings into a new level of breadth, we need to spend more and more time keeping track of the great volume of positions that a portfolio has exposure to. Specifically, because of the scaling benefits presented by fund portfolios, and the sheer inclusivity of conglomerate companies, a personal investor needs to be wary of situations where they might be implicitly increasing their exposure to specific risks.
Between holding multiple fund positions that both hold positions in a given company, or a monster corporation holding a beneficial position in another security, we need to be aware of how it is that our investments expose us to other investments, and how it is that an entire portfolio can be unraveled by a single risk set.
Mutual and Exchange-Traded Funds have provided investors with access to industrial-grade diversification. Today, the modern portfolio will offer investors access to as many as 200 positions to diversify their portfolio through a single position. While these solutions might actually provide a one-stop solution for many, they will more often than not act as a single piece of a greater portfolio.
However, if an investor is not careful to examine the holdings of each of their fund’s holdings, they might not realize that they are being exposed to the same few companies over and over again. Especially when dealing with high-yielding funds that cover specific indexes, the redundant exposure can sometimes be so extreme that they dictate almost all of both the risks and return opportunities associated with the portfolio itself. If such is the case, then the investor might as well have simply put their funds in those over-exposed positions in the first place, and saved the expenses in the first place.
The second kind of redundant exposure that many investors don’t think to examine comes from conglomerations. Specifically, as larger companies (financial companies in particular) gain access to massive amounts of capital, they need to start finding ways to efficiently deploy their capital. This means that they begin taking on sizable ownership positions in profitable companies, to the point at which the performance of these smaller firms will constitute a material impact on the larger’s incomes.
If an investor then owns a position in both companies, they are doubly exposed to the incomes and short-falls of the small position. Ever held a position in a major financial institution that trades equities on a proprietary basis? If so, you’ve very likely been exposed to this degree of risk because of the sheer volume of equity positions that these companies will hold.
Understanding how it is that these different types of redundancies can creep into your personal portfolio, we need to be able to understand a couple of strategies for tracking their presences at a glance before investigating further. From there, we can begin to improve the integrity of the diversification that we employ into our portfolios, and ensure a greater quality of protection in general.