Introducing Genuine Portfolio Diversification (GDP)

The comments below are an edited and abridged synopsis of an article by DeRisk

Diversification is the bedrock of sound investing, but today it is just an illusion. This is because while the rules of sound investing have not changed over the last 100 years, the design of the financial markets has.

Introducing Genuine Portfolio Diversification (GDP) | BullionBuzz
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The fiat financial system has become a system of dependencies. Because the majority of financial products are derivatives whose value depends upon other assets held by a counterparty, if one component of the system (assets, banks, clearing houses, insurers and brokers) fails, all fail. We saw this during the 2008 Financial Crisis when a single bank, Lehman Brothers, almost brought down the entire system.

This inter-dependence of the financial system’s components is the root cause of the illusion of diversification.

It can be argued that government will bail out the system. But will they? Governments have not always acted in the best interests of investors. Indeed, the need for bailouts illustrates the design issues the fiat system faces that current portfolio diversification does nothing to address.

The current illusion of diversification can be dispelled and genuine diversification restored in two steps.

First, all fiat financial products are one system, separate lightbulbs in series. All assets are part of an interdependent whole.  Failure of the fiat financial system, for whatever reason, can have catastrophic effects on the value of assets dependent upon it. Genuine diversification within this single system is not possible.

Second, re-constitute the portfolio with assets that are stand-alone systems of value, independent of other systems. In other words, emulate Google and Amazon in building a distributed network of value where the failure of any component does not jeopardize the value of the entire portfolio.

The reconstitution of the portfolio is a practical task. When the criteria for inclusion becomes one of self-contained systems of value independent of other assets, the range of options are limited but clear. They include property, owned outright; commodities, including precious metals, physically held and owned outright; digital currencies; and fiat-based assets. Outright ownership is required in order to preserve the independence of the asset from the fiat system.

All asset classes, except fiat-based assets, can be held as multiples. For example, holding physical gold, silver and platinum all increase the diversification of the portfolio. Each is an independent silo of value from others. The same is true of property.

The simple test to establish whether an asset is adding to the diversification of a portfolio is to ask if it has stand-alone value or if its value dependent upon the value of other assets.

If the fiat system fails, how many assets in your portfolio would still be standing?

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