I’m a Philadelphia sports fan and for those that don’t follow sports or do follow sports, but don’t pay close attention to the Philly sports scene, allow me to fill you in – we’re cursed. It’s not one team ala the Chicago Cubs or Boston Red Sox – it appears to be the entire city. If I sound bitter, it’s because I am. Our latest disappointment saw our best basketball player and great hope Joel Embiid of the 76ers go down with a knee injury and it all but ended our season. Bitterness aside, there’s actually a relevant message in here – allow me to elaborate.
Embiid was the leading scorer in the NBA before his injury, averaging nearly 35 points per game. He was also the team’s leading rebounder. This season with Embiid the Sixers were 28-12 and all but guaranteed a high seed in the playoffs. Without him they are 14-27 and amongst the worst in the NBA. While it’s not unusual for a team to suffer when they lose their best player, this is quite a precipitous drop in performance. But it’s not surprising given the team relied so heavily on him that his absence left a great void in scoring and rebounding and as a result, winning. Here is where the parallels with investing can be drawn.
Consider this: When a portfolio leans too heavily on one asset class, or one sector or even one company, it is similarly vulnerable. The less diversified a portfolio is across asset classes, sectors and/or geography, the more susceptible it is to drastic swings in performance. This is especially true when one has an oversized position in the stock of one company. Despite how we might feel about that company, the truth is we don’t know what the future holds. If the corporate equivalent of a knee injury were to occur, it would have an outsized negative impact on the overall performance of the portfolio. This is the reasoning behind diversification – to soften the blow of such an occurrence. It’s also why we often encourage our clients to develop a selling plan for their concentrated stock, wherein a fixed number of shares are sold at a fixed interval regardless of the price of the stock. This serves the twofold purpose of taking some risk off the table while maintaining a position in the stock. Admittedly, it’s sometimes a difficult decision to make because we tend to become emotionally attached to these companies, just like fans can fall in love with a player. But the truth is that the 76ers and our investment portfolios might be in a much better position to withstand adversity if their performance were derived from a variety of sources and not just a few or even just one.
