Diworsification (Investopedia Link) and Diversification

Diworsification or Diversification? The distinction matters.

What is Diworsification? “The term “Diworsification” was coined by legendary investor Peter Lynch in his book, One up on Wall Street, to describe the over-expansion of a company into new growth projects and businesses they do not fully understand, and which do not align with the company’s core competencies.” – Investopedia

“The term Diworsification has since grown to also refer to over-diversifying an investment portfolio in such a way that it reduces the overall risk-return characteristics.” – Investopedia

Diversification can often reduce overall investment risk. I am a firm believer in sound diversification. That is one reason I own shares of VYM, SCHD, and DGRO.  But diworsification is adding investments in such a way that the risk-return tradeoff is increased rather than enhanced. “Diworsification occurs from investing in too many assets with similar correlations that add unnecessary risk to a portfolio without the benefit of higher returns.” – Term of the Day from Investopedia, Mack Wilowski

FCNTX is a very top-heavy me-too investment.
Do you see the problem with the top five and the top ten? This is not the best diversification model. It is like the S&P 500 Index only worse.

Are You Top-Heavy?

Some of the world’s worst maritime disasters have been the result of having too much of the weight of a ship above the waterline. The heavy part of the ship tends to pull the ship into the water or can cause it to capsize. Some investments are just like a ship that has too much cargo above the waterline.

Fidelity Investor Community (FIC)

Most mornings I check the FIC for questions I might be able to answer or to look for investment ideas from other investors. This morning I saw the following question from one of the forum’s participants: “I took a small position in Fidelity Contra Fund in October 2020 and added in small increments (it’s still a small position).  It’s down almost 8% since then.  I’m think of selling and using proceeds to buy either ITOT or FNCMX.  I know that Contra performs very well over the long term.  Maybe I’m just getting antsy.  I would appreciate other’s thoughts on Contra:  worth owning or not?

I took five minutes to review FCNTX (Fidelity Contra Fund) and responded as follows:

“I see you have decided to hold the position as I reviewed other’s comments and your responses. I would not recommend this fund to friends and family.” Someone else said what I was thinking. That community member said, “In the very early days of fund I felt it was worth owning but does it really invest as its name might suggest Contra and its definition ” It invests in securities of companies whose value the advisor believes is not fully recognized by the public.”?

He went on to say, “It has strayed from its stated intentions long ago, just look at its top ten holdings for a clue. I sold it more than 20 years ago never to own it again. It seems to me it is just another large cap fund that follows the herd. There is nothing “Contra” about this fund.”

So I said, “I tend to agree with (name) that it is a follow-the-large-cap herd. However, if you like the allocation in the top five, then hold it. I dislike the heavy weighting, but I don’t have long-term issues with the top five. My issue is that there are other good funds with a less top-heavy allocation. I have to wonder why the fund even bothers to hold 339 positions. It feels like the fund managers are dabbling in other stuff. I do hold positions in AMZN and MSFT, but I don’t hold them this overweighted. I’d also have to wonder how much of your investment in other funds has a similarly top-heavy leaning.”

What Were the Results of the Conversations? The person who asked the question, said this:

“I agree; I realized that it appears to have strayed from its initial intentions and appears to be another large cap growth fund.  However, it has been around a long time, has the same manager and makes money.  My position is relatively small so holding it is not much of a risk.”

To that, the person I agree with said, “Maybe so, small holding = small risk but a small holding also = small gains, so then what would be the point in holding it? Morningstar gives it a risk rating of 2 stars.

Recommendation

Don’t buy a fund thinking it is reducing risk and increasing your diversification. You might be increasing your risk. I think FCNTX is an excellent example of top-heavy investing.

Full Disclosure

Cindie and I own shares of MSFT and AMZN, so I am not anti-large-cap investments.