DFAU: When Diversification Becomes A Problem, Not A Solution

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Khaosai Wongnatthakan The Dimensional US Core Equity Market ETF (NYSEARCA:DFAU) is a plain vanilla ETF that’s benchmarked against the Russell 3000. With greater diversity than more traditional broad ...

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With greater diversity than more traditional broad ...</p>\n\n<a href=\"https://seekingalpha.com/article/4704043-dfau-when-diversification-becomes-a-problem-not-a-solution\">Source Link</a>\n\n</div>\n","source":"seekingalpha_fund","html":"<!DOCTYPE html>\n<html>\n<head>\n<meta http-equiv=\"Content-Type\" content=\"text/html; charset=utf-8\" />\n<meta name=\"viewport\" content=\"width=device-width,initial-scale=1.0,minimum-scale=1.0,maximum-scale=1.0,user-scalable=no\"/>\n<meta name=\"format-detection\" content=\"telephone=no,email=no,address=no\" />\n<title>DFAU: When Diversification Becomes A Problem, Not A Solution</title>\n<style type=\"text/css\">\na,abbr,acronym,address,applet,article,aside,audio,b,big,blockquote,body,canvas,caption,center,cite,code,dd,del,details,dfn,div,dl,dt,\nem,embed,fieldset,figcaption,figure,footer,form,h1,h2,h3,h4,h5,h6,header,hgroup,html,i,iframe,img,ins,kbd,label,legend,li,mark,menu,nav,\nobject,ol,output,p,pre,q,ruby,s,samp,section,small,span,strike,strong,sub,summary,sup,table,tbody,td,tfoot,th,thead,time,tr,tt,u,ul,var,video{ font:inherit;margin:0;padding:0;vertical-align:baseline;border:0 }\nbody{ font-size:16px; line-height:1.5; color:#999; background:transparent; }\n.wrapper{ overflow:hidden;word-break:break-all;padding:10px; }\nh1,h2{ font-weight:normal; line-height:1.35; margin-bottom:.6em; }\nh3,h4,h5,h6{ line-height:1.35; margin-bottom:1em; }\nh1{ font-size:24px; }\nh2{ font-size:20px; }\nh3{ font-size:18px; }\nh4{ font-size:16px; }\nh5{ font-size:14px; }\nh6{ font-size:12px; }\np,ul,ol,blockquote,dl,table{ margin:1.2em 0; }\nul,ol{ margin-left:2em; }\nul{ list-style:disc; }\nol{ list-style:decimal; }\nli,li p{ margin:10px 0;}\nimg{ max-width:100%;display:block;margin:0 auto 1em; }\nblockquote{ color:#B5B2B1; border-left:3px solid #aaa; padding:1em; }\nstrong,b{font-weight:bold;}\nem,i{font-style:italic;}\ntable{ width:100%;border-collapse:collapse;border-spacing:1px;margin:1em 0;font-size:.9em; }\nth,td{ padding:5px;text-align:left;border:1px solid #aaa; }\nth{ font-weight:bold;background:#5d5d5d; }\n.symbol-link{font-weight:bold;}\n/* header{ border-bottom:1px solid #494756; } */\n.title{ margin:0 0 8px;line-height:1.3;color:#ddd; }\n.meta {color:#5e5c6d;font-size:13px;margin:0 0 .5em; }\na{text-decoration:none; color:#2a4b87;}\n.meta .head { display: inline-block; overflow: hidden}\n.head .h-thumb { width: 30px; height: 30px; margin: 0; padding: 0; border-radius: 50%; float: left;}\n.head .h-content { margin: 0; padding: 0 0 0 9px; float: left;}\n.head .h-name {font-size: 13px; color: #eee; margin: 0;}\n.head .h-time {font-size: 11px; color: #7E829C; margin: 0;line-height: 11px;}\n.small {font-size: 12.5px; display: inline-block; transform: scale(0.9); -webkit-transform: scale(0.9); transform-origin: left; -webkit-transform-origin: left;}\n.smaller {font-size: 12.5px; display: inline-block; transform: scale(0.8); -webkit-transform: scale(0.8); transform-origin: left; -webkit-transform-origin: left;}\n.bt-text {font-size: 12px;margin: 1.5em 0 0 0}\n.bt-text p {margin: 0}\n</style>\n</head>\n<body>\n<div class=\"wrapper\">\n<header>\n<h2 class=\"title\">\nDFAU: When Diversification Becomes A Problem, Not A Solution\n</h2>\n\n<h4 class=\"meta\">\n\n\n2024-07-15 17:53 GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4704043-dfau-when-diversification-becomes-a-problem-not-a-solution><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>Khaosai Wongnatthakan The Dimensional US Core Equity Market ETF (NYSEARCA:DFAU) is a plain vanilla ETF that’s benchmarked against the Russell 3000. With greater diversity than more traditional broad ...</p>\n\n<a href=\"https://seekingalpha.com/article/4704043-dfau-when-diversification-becomes-a-problem-not-a-solution\">Source Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","isBrief":false,"type":0,"news_type":1,"symbol":"OEF","symbol_name":"标普100指数ETF-iShares","start_time":0,"source_url":"https://seekingalpha.com/article/4704043-dfau-when-diversification-becomes-a-problem-not-a-solution","article_id":"2451614605","we_media_id":null,"thumbnails":["https://static.seekingalpha.com/cdn/s3/uploads/getty_images/1363726198/image_1363726198.jpg"],"rights":null,"url":"https://stock-news.laohu8.com/highlight/detail?id=2451614605","pubTimestamp":1721037228,"sourceInfo":{"source_id":"seekingalpha_fund","name":"Seeking Alpha"},"weMediaInfo":null,"summary":"or the SPDR S&P Biotech ETF  after the pandemic-driven rally more than doubled the value of this ETF.   SA …or the healthcare sectors’ - both U.S. and global - divergence from the bro","collect":0,"end_time":0,"defaultTopTitle":"seekingalpha.com","property":[],"viewcount":null,"language":"en","relate_stocks":{"OEF":"标普100指数ETF-iShares","LU0742534661.SGD":"Fidelity America A-SGD (hedged)","BK4574":"无人驾驶","IAT":"安硕美国地区银行ETF","IE00B4R5TH58.HKD":"JANUS HENDERSON GLOBAL LIFE SCIENCES \"A2\" (HKD) ACC","LU1496350502.SGD":"FRANKLIN DIVERSIFIED DYNAMIC \"A\" (SGDHDG) ACC","OEX":"标普100",".SPX":"S&P 500 Index","IE00BLSP4452.SGD":"Legg Mason ClearBridge - Tactical Dividend Income A Mdis SGD-H Plus","IVV":"标普500指数ETF","BK4504":"桥水持仓","AVGO":"博通","BK4581":"高盛持仓","LU0234570918.USD":"高盛全球核心股票组合Acc Close","LU0456855351.SGD":"JPMorgan Funds - Global Equity A (acc) SGD","LU0417517546.SGD":"Allianz US Equity Cl AT Acc SGD","FDN":"First Trust Dow Jones Internet I","BRK.B":"伯克希尔B","SDS":"两倍做空标普500ETF","UPRO":"三倍做多标普500ETF","LU0719512351.SGD":"JPMorgan Funds - US Technology A (acc) SGD","LU0640476718.USD":"THREADNEEDLE (LUX) US CONTRARIAN CORE EQ \"AU\" (USD) ACC","LU0471298777.SGD":"Blackrock Nutrition A2 SGD-H","IE00BMPRXR70.SGD":"Neuberger Berman 5G Connectivity A Acc SGD-H","SPY":"标普500ETF","LU0234572021.USD":"高盛美国核心股票组合Acc","LU1037948541.HKD":"AB LOW VOLATILITY EQUITY PORTFOLIO \"A\" (HKD) ACC","IE00BMPRXN33.USD":"NEUBERGER BERMAN 5G CONNECTIVITY \"A\" (USD) ACC","XBI":"SPDR S&P Biotech ETF","LU":"陆金所","IE00BZ1G4Q59.USD":"LEGG MASON CLEARBRIDGE US EQUITY SUSTAINABILITY LEADER \"A\"(USD) INC (A)","SSO":"两倍做多标普500ETF","IE00BWXC8680.SGD":"PINEBRIDGE US LARGE CAP RESEARCH ENHANCED \"A5\" (SGD) ACC","SH":"标普500反向ETF","SPY.AU":"SPDR® S&P 500® ETF Trust","IWV":"iShares Russell 3000 Index Fund","LU1032466523.USD":"高盛全球多资产收益组合Acc","SPXU":"三倍做空标普500ETF","DFAU":"Dimensional US Core Equity Market ETF","LU0320765059.SGD":"FTIF - Franklin US Opportunities A Acc SGD","LU0672654240.SGD":"FTIF - Franklin US Opportunities A Acc SGD-H1","IE00BMPRXQ63.HKD":"NEUBERGER BERMAN NEXT GENERATION CONNECTIVITY FUND \"A\" (HKDHDG) ACC","BK4527":"明星科技股","LLY":"礼来","LU1548497426.USD":"安联环球人工智能AT Acc","LU1064131342.USD":"Fullerton Lux Funds - Global Absolute Alpha A Acc USD","BK4588":"碎股","TSLA":"特斯拉","LU0154236417.USD":"BGF US FLEXIBLE EQUITY \"A2\" ACC"},"translate_title":"DFAU：当多元化成为问题而不是解决方案时","themeId":null,"isJumpTheme":false,"ttsUrl":null,"symbols_score_info":{"AVGO":1,"XBI":1,"SPY.AU":1,"SPY":1,"LLY":1,"IWV":1,"IAT":1,"DFAU":1,"BRK.B":1,"FDN":0.9,".SPX":0.6,"OEF":0.6,"OEX":0.6,"SDS":0.6,"SH":0.6,"SPXU":0.6,"SSO":0.6,"UPRO":0.6,"IVV":0.6,"ESmain":0.6,"LU":0.6,"TSLA":0.3},"content_text":"Khaosai Wongnatthakan The Dimensional US Core Equity Market ETF (NYSEARCA:DFAU) is a plain vanilla ETF that’s benchmarked against the Russell 3000. With greater diversity than more traditional broad market ETFs that seek, for example, to replicate the performance of the SP500, it’s an ideal investment vehicle for the volatile times ahead - or so it would seem. The only problem is that diversification strategies aren’t designed to deliver alpha, and you could end up wondering for years why your highly diversified portfolio isn’t beating the market and protecting your investments at the same time. The issue here is that these are two entirely different things, and diversification isn’t intended to achieve both these goals. DFAU Essentials DFAU being a broad market ETF that tracks the Russell 3000, you won’t see a very high expense ratio. On that front, 0.12% is about par for the course, although it’s much lower than the median figure of 0.49% for all ETFs. The high diversification indicates that it is not much of a concentration risk in terms of underlying assets; but, like the market itself, it’s currently skewed toward tech, finance, healthcare, and consumer cyclical, which total about 66% or two-thirds of the ETF’s holdings. Still on the concentration part, you’ll also notice that roughly a third, or 31% of the fund is allocated to its Top 10 Holdings, which feature six of the seven ‘magnificent’ equities alongside companies like Berkshire Hathaway (BRK.B), Broadcom (AVGO), JPMorgan Chase (JPM), and Eli Lilly (LLY). DFAU’s technical indicators show that it’s in overbought territory (RSI>70), but so is the broader market when you look at proxies like the SPDR® S&P 500® ETF Trust (SPY) and the iShares Russell 3000 ETF (IWV).   Investech On the one hand, there don’t seem to be any negative signals in the medium term, but the mega-caps that DFAU holds being in overbought territory is always a warning sign. Any significant correction within the Mag 7 universe (except Tesla (TSLA), which isn’t part of the Top 10 holdings) could lead to DFAU taking a downturn. The impact would be far more marginal than in a less diversified portfolio, of course, but it’s nonetheless one of the risks to be aware of. That brings us to the point about diversification. While diversification is a good strategy for risk-averse investors, it does have its disadvantages. In the sections below, I discuss both the pros and the cons of having a highly diversified portfolio. Why Diversification Is Important The logical basis for diversification is that different sectors perform differently under certain market conditions. Case in point: look what happened to a sector-specific basket of securities like the iShares U.S. Regional Banks ETF (IAT) during the regional banking crisis last year…   SA …or the SPDR® S&P Biotech ETF (XBI) after the pandemic-driven rally more than doubled the value of this ETF.   SA … or the healthcare sectors’ - both U.S. and global - divergence from the broader market’s performance since March of this year.   SA There are numerous such examples that lend credence to the case for diversification, because it gives you a certain amount of protection against sector-centric downturns in the market. If your portfolio was heavily weighted to biotech right after the pandemic and through the first quarter of 2021, you would have done phenomenally well against a more diversified portfolio; however, if you’d held those same securities past that, all your unrealized gains would have converted into unrealized losses. Similarly, if your portfolio was weighted to regional banks in March 2023 and beyond or the healthcare sector beyond February 2024, your investment would have either gradually or rapidly declined in value. They say time is a great healer. Unfortunately, the market doesn’t work that way. A 50% portfolio loss would need a 100% gain to get back to its old level. Lose $50 in a $100 investment, and you’ll need to double that to get back to $100. This volatility drag or decay is one of the reasons the stock market is such a risky investment vehicle, and diversification is one of the ways to mitigate this major risk. I hope that sets the tone for the ensuing discussion on diversification, and DFAU’s potential role in your portfolio. The Downside to Diversification So, there’s no doubt that diversification of your portfolio will, to the extent that you diversify it, protect it against sector-based downturns. Depending on the geographic spread of your holdings, it might even protect you from country-specific risks. The only problem here is that it limits your upside. In a way, diversification sends a clear signal that you’re trading off alpha for more stability, and that’s actually a reasonable trade-off when you’re investing your hard-earned cash and want to limit the risks. So, why am I calling it a ‘problem’? Well, not many investors invest in capital markets for the sake of stability. There’s a reason this website is called what it’s called. Retail investors are in the game to take on some amount of risk in exchange for a much higher reward than investing in so-called ‘safe’ assets like government bonds, real estate, precious metals, and other traditional asset classes that generally have more predictable returns or are considered relatively safe in the long run. Gold, for example, has appreciated from around $473 at the beginning of 2000 to a little more than $2411 as of the time of writing this - a period of 24 years with a CAGR of a shade over 7%. That’s not too bad, but that would be your nominal return. What’s your real return, adjusted for inflation? To offer a back-of-the-envelope calculation, the 1999-chained CPI-U (All Urban Consumers) as of June 2024 is about 175, which translates to a 75% inflation figure for that period, so if you apply that to your nominal return of $2411 - $473 = $1938, your real return is actually $1107, bringing your CAGR down to 5.15%. I trust my calculations are correct, but please let me know if it’s off. The point, however, is that the more predictable the outcome, the lower the return. That’s where the risk element comes into the picture. Now, assume you invested in SP500 in 2000 using a vehicle like the SPY. Your $145 investment (1 SPY unit at the time) would now be worth roughly $560 for a CAGR of about 5.8% nominal and 4.1% real. That’s not even as much as an investment in physical gold would have fetched you in that same 24-year period. And that’s why I called it a problem. Of course, I’ll be the first to point out that this is not a problem of diversification, but one of risk. You took a greater risk with a different asset class (stocks vs gold), and that risk dragged down your return by more than a percentage point below an investment in gold. Diversification poses a different but related sort of problem, even though it might appear to equate to a lower amount of risk when compared to a less-diversified portfolio. That problem is even bigger than the one with the asset class variance we just saw, and the problem is that your upside could be increasingly limited the more you diversify your portfolio. And that’s also why I would not recommend DFAU as a good investment. With nearly 2400 stocks in its portfolio, this is as diversified as they come, and that limits your upside to that of the broader market. Of course, when the market is doing well, it gives you a good return, but that also means actively managing your portfolio to make sure you do two things: a) keep trimming your position as the market’s overall valuation goes higher and higher, and then adding back to your position when valuations dip below historical averages, and/or b) use weightings to rotate out of badly performing sectors and into better-performing ones. For example, the Russell 3000’s aggregate P/E ratio as represented by IWV is currently above 26x, and you can see from the graph below how it is gradually starting to diverge from the performance of the less-diverse SPY.   SA That’s the problem I wanted to highlight with this article. Diversification is a great tool for risk-averse investors, but it limits your upside when certain segments of the market are performing much better than others. Of import is the fact that other sectors aren’t necessarily doing badly, but a select few are clearly outperforming them, as shown in the table below.   Charles Schwab When the market is clearly skewed towards a few sectors, that’s where at least a portion of your money should be concentrated. If you’re honest with yourself, you came to the stock market with a willingness to take on some risk and hopefully make a little more than you would from investments in relatively safer and more stable asset classes. Diversification makes it hard to do that, as we saw in the case of gold vs a diversified stock portfolio. DFAU is even more diversified than SPY, so why would you invest in something as broad as that? That’s my question to you. Can You be Diversified and Still Generate Alpha? As a mitigatory strategy, periodically rebalancing your portfolio based on recent and prevalent trends in the market can help you generate that alpha you’re seeking. As an example, if you had weighted your portfolio to sectors that were trending nicely over the past year, such as information technology, communication services, financials and even energy, your rate of return would be that much higher than DFAU’s 16% YTD return and even the SPY’s near-18% YTD return. To be clear, I’m not asking you to throw caution to the wind and put all your eggs into one, two, or even three baskets. All I’m saying is that your core portfolio can be as diversified as you like but, depending on your tolerance for risk, reserve at least 20% to 50% of it for sector-specific investments when the trends clearly favor those sectors. The likelihood of an entire sector losing value overnight is as remote as a pandemic or a regional banking crisis; most of the time, it’s a gradual and clearly visible divergence from the broader market, as in the case of the healthcare segment that we saw in one of the examples above. The good part is that sudden shockers tend to play out favorably over time and these distressed assets tend to recoup quite a lot of their losses over time; not always, but most of the time, and that’s really where diversification can be an effective tool to help mitigate those losses in the short term. Just don’t let it be a problem that hampers your potential returns from specific segments that may be more volatile but are generally in an upward trend pattern. That’s also why I won’t give DFAU an outright Buy recommendation. Yes, it’s a good investment to stabilize your portfolio, but don’t make its underlying principle of diversification the end goal of your investment strategy. An Afterthought I do believe that investing should be a passive activity where you begin with a long-term, buy-and-hold mindset. That doesn’t mean you need to be passive when things go wrong. All it means is that you don’t make hasty decisions and sell off massively just because an asset dropped a few percentage points overnight on bad news. Instead, dive into the situation in an active manner, read up on what analysts here on Seeking Alpha are saying about the development, and then arrive at a decision in a calm, collected frame of mind with all the facts you need to inform you. In other words, do your due diligence the way it’s intended to be conducted - by getting the information you need, assessing the risk with your own unique set of parameters, valuing the potential reward in a likewise manner, and then taking the most appropriate action based on what your analysis points to.  Good luck to you in your investment journey.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2451614605"}