Diversification is heavily misunderstood in the investment business. I’d argue most portfolios aren’t very diversified.
They look diversified. They own dozens, sometimes hundreds of securities across stocks and bonds. But underneath the surface, they’re really just exposed to one or two risks.
A traditional portfolio is largely driven by economic growth and inflation. And because stocks tend to dominate the overall risk of the portfolio, it’s mostly just growth.
Fortunately, the economy is usually growing, so this works fine most of the time… until it doesn’t.
When Diversification Fails
The recent conflict in Iran has been a real-time stress test for markets.
Stocks have declined.
Bond prices are falling.
Oil surged above $100
Gold, which many view as a hedge, has fallen sharply.
At the same time, expectations for the Federal Reserve have shifted dramatically. What was once a market pricing in multiple rate cuts has now turned into a scenario where hikes are back on the table.
This is exactly the kind of environment where diversification is supposed to help.
Instead, “balanced” portfolios have struggled.
Why?
Because the assets that are supposed to diversify each other were all reacting to the same underlying force: rising and unexpected inflation pressures.
A traditional balanced portfolio is structurally exposed to that risk. When inflation surprises to the upside, both stocks and bonds can fall at the same time (remember 2022?). Even assets like gold, which are historically viewed as protection, don’t always behave as expected.
What Real Diversification Actually Means
Diversification isn’t just owning more things; it’s owning different things.
Most traditional investments derive their returns from the same core drivers. Even when you own different types of stocks or different types of bonds, you’re often just slicing those same exposures in slightly different ways.
True diversification requires stepping outside of that framework, and asking the question:
Why am I actually getting paid to own this investment? What risks am I taking?
If the answer sounds the same for every piece of the portfolio, you may not be diversified. Sometimes that means you need to look towards areas that feel less familiar.
Reinsurance, for example, is driven by insured losses from natural disasters. Its return profile has little to do with GDP growth or central bank policy.
Other strategies, like macro or equity market neutral, attempt to extract returns from relative value or positioning rather than broad market direction.
And then there are strategies like “carry.”
Carry can be a bit difficult to understand at first, largely because it’s implemented using derivatives like futures contracts. But conceptually, it’s actually pretty straightforward.
At its core, a carry strategy is taking advantage of differences between the price of something today and the price for that same thing in the future. In many markets, those two prices don’t match. They reflect supply and demand dynamics, storage costs, and the urgency of needing the asset now versus later.
In normal environments, these relationships tend to be relatively stable, which allows a strategy to systematically capture the price differences. Over time, that can create a return stream that isn’t dependent on whether markets are broadly rising or falling. You simply get paid for “carrying” the asset.
While it may feel unfamiliar, this type of strategy has been used for decades across commodities, currencies, stocks, and fixed income markets, primarily by institutional investors and hedge funds looking to diversify beyond traditional stock and bond exposures.
Why It Worked Here
What made the recent environment unique was how disruptive the war has been to oil and gas supply.
In a matter of days, oil quickly jumped to over $100 a barrel. A sudden supply shock in energy markets created a surge in demand for oil today, but what you might not know is that you can buy oil today at a different price for delivery in the future. In this case, you could buy oil for something like $75 a barrel to be delivered in 6 months, while oil for immediate delivery was $100. A trader could pay that $75 and collect the $25 difference as profit once the term ends (assuming stable prices).
A carry strategy is designed to identify and capture opportunities like this in dozens of different markets. Not because it predicts geopolitical events, but because it is built to respond when pricing relationships become unusually attractive, as it did in oil.
In this environment, that positioning has been beneficial. For example, the carry strategy we utilize has generated strong double digit returns year to date, while traditional stock and bond markets have generally struggled or lost money.
This Isn’t About Chasing What’s Working
It’s important to be clear about what this is, and what it isn’t.
This isn’t about finding something that worked after the fact.
In reality, strategies like carry can go through extended periods where they struggle. In fact, this carry strategy was struggling prior to us purchasing it last year and struggled a bit after our initial purchase.
The reason to own it isn’t because it always works.
It’s because it represents a different source of return, which is time-tested and well researched and can perform well in environments where traditional assets do not.
And when it does, it can play a meaningful role in stabilizing the overall portfolio.
Diversification is one of the core pillars of what we do, but not in the traditional sense of simply owning more securities or more asset classes.
Instead, the focus is on identifying and combining truly differentiated return streams. Some of those will overlap. Some will not work at the same time. That’s expected.
The goal isn’t perfection. It’s resilience.
Because environments like the one we’re seeing today are not predictable in advance. But they are inevitable.
And when they occur, the difference between a portfolio that looks diversified and one that truly is becomes very clear.
Key Takeaways
Most portfolios only appear diversified—they’re largely driven by growth and inflation.
Traditional diversification can fail when inflation shocks hit, causing assets to fall together.
True diversification means different return drivers, not just more holdings.
Strategies like carry provide alternative, less correlated return streams.
The goal isn’t perfection—it’s building a more resilient portfolio.
PAST PERFORMANCE IS NOT A GUARANTEE OF CURRENT OR FUTURE RESULTS. Examples of historical information included in this presentation do not, nor are they intended to, constitute a promise of similar future results. Specific client portfolio allocations, risks and returns can and may deviate from these examples depending on accounts and types of investments available through each account. Future market views by WJ Interests, LLC may vary significantly from the historical examples presented herein and no one receiving this summary should assume that WJ Interests, LLC will be able to replicate successful views in the future.