What Is a Granular Portfolio?
A granular portfolio is an investment strategy that achieves broad diversification by holding a significant number of different assets across various sectors and asset classes. This portfolio structure is known for lowering the overall risk profile by minimizing overexposure to any single asset or sector. In contrast, portfolios with low granularity contain fewer positions or highly correlated assets, resulting in higher overall risk.
Key Takeaways
- A granular portfolio encompasses investments across multiple asset classes and sectors.
- The primary advantage of a granular portfolio is risk reduction through diversification.
- Additional benefits include customize financial objectives and diversification flexibility.
- Potential drawbacks include missed windfall gains and increased exposure during market volatility.
How a Granular Portfolio Works
A granular portfolio can consist of various asset classes, including credit, currency, equity, bonds, or a combination of these. Highly granular portfolios are designed to diversify away most of the unsystematic risk (the risk associated with individual securities) so that the portfolio mainly confronts systemic risk, which cannot be mitigated through diversification alone.
Advantages of a Granular Portfolio
Reduces Risk
Investing across many sectors and asset classes helps diminish the portfolio’s overall risk. For example, if the healthcare sector performs poorly, a granular portfolio with investments in technology, financials, and consumer goods can help stabilize returns. Including bonds can provide income and stability during times when stocks are stagnant.
Customization
Granular portfolios allow for tailored adjustments to meet individual financial goals. A younger investor might allocate 90% to equities and the remainder to bonds and cash. As the investor nears retirement, they can reallocate to more conservative assets, showing the flexibility of a granular portfolio to adapt over time.
Asset Choice
Such portfolios provide the flexibility to invest across multiple asset classes. For instance, when precious metals like gold and silver are trending upwards, an investor can add commodities to the portfolio to take advantage of these gains.
Disadvantages of a Granular Portfolio
While advantageous, granular portfolios also have some cons, especially during market instability.
Windfall Gains
Because of its diversified structure, a singular large gain will have a minimal impact on the overall portfolio returns. If a stock within the portfolio jumps by 75%, it only slightly contributes to the total gain if it represents just a small percentage of the overall portfolio.
Exposure
During stable market conditions, uncorrelated assets offsets risks. However, in financial crises, these correlations can change, potentially increasing risks. For instance, in the 2008-2009 financial crisis, equities and commodities became strongly correlated, changing the risk profile. Continuous monitoring of asset correlations is crucial to avoid overexposure.
Related Terms: diversification, systemic risk, unsystematic risk, asset allocation.
