time to deconcentrate? the elegance of a 1/n approach

• Traditional multi-asset strategies take a capitalisation-weighted approach to asset classes
• This creates concentrations towards size adjusted for domestic biases
• A deconcentration strategy provides an equal weight allocation across asset classes and geographies

We are adding the Elston Maximum Deconcentration Portfolio to our suite of multi-asset risk-based strategies.  The portfolio is now "live" with factsheets updated daily (portfolio ticker ESBMDC).

What is "Deconcentration"?
Put simply, in the context of multi-asset investing, if single asset investing is having all eggs in one basket; 60/40 investing is having all eggs in two baskets; then deconcentration is having one egg per basket.  It is diversification at its simplest: giving an equal weight to each asset class within the portfolio.

This portfolio construction approach is known as a "Deconcentration strategy" as it deconcentrates the portfolio from any single asset class.  It is also known as a (1 over N) approach, where N is the number of holdings within the portfolio.

What problem are we trying to solve?
Most traditional multi-asset strategies, such as a 60/40 portfolio, have a capitalisation-weighted approach to asset allocation.  Within  a classic global equity benchmark, for example, the US dominates with a ~60% allocation.  So within a vanilla 60/40 portfolio, US equities may have a 36% allocation (60% US exposure within 60% Global Equity allocation).  Nothing wrong with that, but it's an overweight based on capitalisation.  Likewise within the bond allocation rather than having a bias towards GBP issued bonds under a classic 60/40 approach.  Again, nothing wrong with that, but it limits the diversification impact of international bonds.

How does a max deconcentration portfolio work?
One way of creating differentiated risk-returns is to ignore these size-and-domestic biases is to create a "naive" or simple diversification strategy, such as an equally-weighted multi-asset approach.

We look at an opportunity set of 20 asset class exposures: regional equity markets, bonds by issuer type, maturity and currency, as well as alternatives such as gold, listed infrastructure, property securities.

We then create an equal-weight allocation (1/20 = 5%) to each asset class.  This portfolio thereby provides an alternative approach to multi-asset diversification with differentiated risk-return characteristics.

Does it work?
By default, the risk-return characteristics of a 1/N portfolio will be different to that of a traditional multi-asset portfolio, so a Max Deconcentration strategy will provide a differentiated risk-return characteristic for diversification purposes.

However, there is also research to suggest that a "simple" 1/N portfolio can outperform more "sophisticated" mean-variance optimised portfolios.  For more on this, see De Miguel, Garlappi and Uppal (2009) and related readings.

Obviously the nuance of any 1/N portfolio will depend on its design parameters: the performance of our Max Deconcentration strategy will be included in future multi-asset strategy reviews relative to a 60/40 benchmark as well as other risk-based strategies such as Min Variance and Risk Parity.

Keep updated
To view peformance of this strategy, please refer to our strategy factsheets, published daily, or request portfolio access via Bloomberg.  To replicate this strategy, subscribe to our Advanced Portfolios for weightings files and detialed performance analysis.