Caution! Don't read on if you haven't watched the first episode of the third series of Downton Abbey
Downton Abbey is normally leisurely viewing, but high-net worth (HNW) ears will have pricked last night at the news that Lord Grantham has invested his fortune in a doomed railway company and faces ruin.
Going from hero to zero – with the inevitable family fallout – is something that keeps even the wealthiest awake. So a quick analysis of Grantham’s mistake may put a few minds at rest today.
Diversification is the buzzword of many portfolio managers. Complicated as it sounds, the idea condenses into the simple thought that investing across a series of asset classes, sectors, geographies and maturities achieves the same returns as investing in one stock, but – crucially – with less risk.
The concept is sufficiently appealing that some HNWs go overboard on it though. Breaking their fortunes into a thousand pieces after liquidity events, they unknowingly diversify themselves into mediocrity and ensure that, while safe, their money won’t grow at the rate required to counter inflation, family spending or the taxman.
A balance therefore needs to be struck, and Lord Grantham would have done well to listen to the advice of Murray, his money manager, in this department.
Academics currently posit that the vast majority of diversification benefits can be achieved with 12 to 18 holdings. This represents a happy balance between, at one end, concentrated investment in the few first class opportunities that come our way in a lifetime, and, at the other, the don’t-put-your-eggs-in-one-basket mentality.
What it comes down to is that when you are worth hundreds of millions – as Lord Grantham was – the battle is not so much investment management as risk management.
Wealth preservation is the Holy Grail, and the fallout of failing to achieve it will be graphically laid out in Julian Fellowes' third season.
This article first appeared in Spear's.