Check out our most recent CM Group- Free Lunch Podcast, Episode 26 “The 60/40 Versus The Death Star Portfolio” for an in-depth review of this strategy in terms of how it compares to the construction of The Death Star and what a Death Star Portfolio is...
The current stock market woes remind us of the woes of the Galactic Empire, also known as the New Order.
As you may be aware in many of the Star Wars movies, The Empire spends a great deal of time and resources constructing a newer version of the death star. The purpose of the death star is to destroy an entire planet with a single shot, the ultimate power.
In the original Star Wars movie, Luke Skywalker blows up the death star to end the strangle hold that the Galactic Empire has on the rebel forces. Lately, I have been thinking about the futility of continuing to build the next best death star and how it relates to investment portfolios.
You could liken the death star to a highly concentrated portfolio, one that has the opportunity to have excess return with its massive power. In Calgary, many investors have invested this way by having highly concentrated portfolios that hold mostly energy stocks. These portfolios have looked really good in the past, when oil was trading north of $90 per barrel and there was a lot of activity in “the patch.”
The downfall of the Death Star in the original Star Wars was when Luke Skywalker closed his eyes and used “the Force”, sending a torpedo into the main reactor causing a chain reaction, which resulted in the entire station’s destruction.
“Great shot, kid! That was one in a million!”
- Han Solo to Luke Skywalker
The Empire did not believe that a single shot could take down such a huge battle ship and so it was blind sided by this rebel attack. This is similar to stock markets and highly concentrated portfolios. These portfolios are forms of the death star, in that they can be taken down by a single torpedo, which in this case could be the price of oil falling from its high price of $107.50/barrel in June of 2014 to today’s price of just over $38/barrel. A drop of more than 64% in total return.
I wonder what would have happened if The Empire had not focused so much of its capital and resources on building that one mega destroyer. For example, If they had diversified their attack weapons. When we compare the performance of a global equity position, one that we quite often recommend which is the DFA Global Equity Portfolio, we see that in that same time period of June 2014 to today, a well diversified portfolio had an annualized rate of return of more than 6%.
In one article I recently read it stated that the original Death Star would have taken 800,000 years to construct at a total cost of $852 quadrillion or roughly 13,000 times the worlds GDP. And there have been multiple death stars built and destroyed again and again. That is very expensive and time-consuming behavior.
What if we likened the original Star Wars movie to the credit market of 2008-2009? During that time period we saw massive sell offs on various markets and investors who had highly concentrated portfolios, or a Death Stars, experienced really bad returns. Our hope is that investors learned a lesson that The Empire did not. Those investors didn’t go and try and build another Death Star after the credit market recovered. Instead they built a well-diversified portfolio.
As we see in subsequent Star Wars movies, the odds of another Death Star picking up and defeating the Rebel Forces did not change. Each one was defeated over time. As much as The Empire thought that it would be different this time… it wasn’t.
“I find your lack of faith disturbing.”
- Darth Vader
Our advice is to not focus on building that Death Star, whether that means hiring a portfolio manager to have a concentrated portfolio or building one your self. We would advise investors to consider diversifying their holdings and focus on what they can control.
Investing works, but only over long periods of time. You must use “the Force” of investing; having highly diversified portfolios, focusing on your asset allocation (not just one deadly planet), reducing your costs and taxes, and managing your emotions. If you follow these steps and stick to a well developed plan you give yourself the opportunity to have a positive investment experience - one that is focused on what is important to you that requires planning, money, and time.
“Do. Or do not. There is no try.”
- Yoda
Happy investing!