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Diversification: The Boring Winner APRIL 2022 In a world where the best- and worst-performing asset classes tend to dominate the headlines, it's easy to lose sight of the fact that a diversified investment portfolio is generally the most reliable approach for meeting long-term investment objectives. Diversification is a time-tested component of portfolio construction, especially through the lens of risk-adjusted returns in terms of Sharpe ratios. Historically, the result is a less volatile portfolio that tends to produce something close to middle-of-the-road performance year in and year out. This is in contrast to the best- and worst-performing asset classes, which often generate significant media attention despite volatility in returns and market leadership—hence the sentiment that diversification is rather boring. Diversification rarely wins in any given year… By design, diversified portfolios hold a mix of asset classes, some of which outperform and some of which underperform in a given year. As a result, diversified portfolios will never beat the top-performing asset class in any given year. However, it's notoriously difficult for investors to consistently pick top- performing asset classes. Nevertheless, to some investors, more-stable diversified strategies lack the appeal of flavor-of-the-month champions like the high-flying technology stocks or rapidly rising emerging markets. This point of view arises from some well-known cognitive and emotional biases, which we have covered at length in our series of Behavioral Finance papers. To counter these biases, we developed a framework based on our analysis of three highly simplified investment strategy types (described below)—which has demonstrated the power of diversification. Trend-Following Strategy: Invests in the top-performing asset class of the prior year Contrarian Strategy: Invests in the worst-performing asset class of the prior year Diversified Strategy: Invests equally in all available asset classes We found that over the last 10 years, the Contrarian strategy beat the other two strategies 50% of the time. The Trend Following approach won in three of those years. And the diversified strategy only came out on top in only one of those 10 years. SNAPSHOT • Year in and year out, a single asset class will often outperform a well- diversified portfolio. • Yet outperformance of any single asset class is notoriously difficult to predict—and a diversified portfolio will tend to outperform over the long run, especially in risk-adjusted terms. • Although the middle-of-the- road performance tendencies of diversified strategies can lead to challenging conversations with some clients, diversifying is still the right thing to do. Kevin P. Barr Executive Vice President Investment Management Unit

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