Fine wine and handbags

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  By Guest Blogger Doug Rowat

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If for some reason you’d been given the highly specific advice five years ago to ‘buy French luxury goods’ you might have bought Hermes International stock and done extremely well (+229%), or you might have bought Kering SA and got destroyed (-59%).

Or maybe you actually bought the physical goods themselves: Chanel handbags, say, and doubled your money (+104%, according to purseblog.com—see the lengths that we go to to bring you this blog?), or instead bought high-end French wine and round-tripped:

Chanel handbags vs the Liv-ex Fine Wine 50 Index

Source: pursebag.com, Liv-ex. The Fine Wine 50 Index tracks the daily price movements of Bordeaux First Growths, including the most recent vintages of Lafite Rothschild, Margaux and Haut-Brion.

The point is that not diversifying is dangerous—even when the favoured region and sector are highly specific, you can still easily choose incorrectly.

Probably no one reading this blog made an actual investment in physical Chanel handbags (kudos if you did), but it’s likely that some readers made an investment in Canadian banks recently. There are only six major banks in this country, of course, with ostensibly the same customer bases and business models, so the divergence in performance this year shouldn’t be dramatic, right? Wrong:

Major Canadian banks – ytd returns (%)

Source: FactSet. Priced mid-day December 5, 2024.

No one would dispute that concentration is the best way to maximize returns, but diversification is the best way to avoid disaster and significantly increase the overall odds of a favourable return. If you’d bought a broad-based ETF that holds Canadian banks, for example, you’ve probably done very well this year. If you made a concentrated bet on Toronto-Dominion Bank and didn’t anticipate its lack of anti-money laundering oversight, billions of dollars in penalties and the sudden “retirement” of its CEO, then your finances are likely a mess. Blue-chip Canadian banks, it turns out, aren’t interchangeable investments.

However, it’s not just the risk of poor security selection that diversification helps ameliorate, the better downside protection offered by a diversified portfolio also helps reduce the costly emotional errors that erode performance.

And then there’s the significantly improved recovery time after a market shock that diversified investors further enjoy. Not only does this make you whole sooner—an obvious plus—but the quicker recovery time also, again, reduces emotion-driven mistakes. No one makes good investment decisions when they’re impatiently waiting for their investments to breakeven.

State Street Global Advisors examined the performance of a generic 60/40 balanced portfolio during past major market downturns and noted that a balanced portfolio often has only about HALF the drawdown of a pure equity portfolio. Better yet, the balanced portfolio’s recovery time was about seven months sooner. When markets are volatile and the daily newsflow terrifying, seven months is an eternity. Only those who have lived through a crisis can understand the enormous temptation to sell at the lows when things appear hopeless. A diversified portfolio significantly reduces this temptation.

Drawdown and recovery analysis” 60/40 balanced vs pure equity

Click to enlarge. Source: State Street Global Advisors

And once you sell, you’re cooked. A 2022 MIT research paper (“When Do Investors Freak Out? Machine Learning Predictions of Panic Selling”) examined panic selling and found that almost 31% of panic sellers NEVER re-enter the equity market while another 20% re-enter only after 11 months or more, likely missing a significant portion of the equity market’s inevitable recovery.

So, diversify. A diversified portfolio prevents you from giving in to those nasty behavioural quirks and biases.

And prevents you from mistakenly loading up on Lafite Rothschild when you should have instead been rocking Chanel ‘classic flap’ bags.

Size medium, of course.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Investment Advisor, Private Client Group, Raymond James Ltd.

Source: https://www.greaterfool.ca/2024/12/07/fine-wine-and-handbags/