Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 505

Passive investing has risks too

In 2022, investors were hit by a double whammy of both equities and bonds suffering similar levels of declines in prices. The perceived wisdom is that this is not supposed to happen. Bonds and equities are meant to be uncorrelated, so that when one struggles the other does well.

The reality is that bonds and equities fall at the same time more often than expected. In fact, a look over history shows the period where equities and bonds were completely uncorrelated is more of an anomaly, particularly in periods of rising inflation.

This means the traditional diversification strategy of 60:40, with 60% in equities and 40% in bonds, is not the silver bullet some may think it is.

Diversification matters in many ways

Now this doesn’t mean you should rip up your investment approach and do something completely different. But it would be foolhardy not to try and learn from recent experience and be more open-minded in your view of what diversification means. It’s not just about different asset classes, although that obviously helps, it’s also about broadening your horizons for different styles, different regions and even combining active and passive strategies.

For many, the active versus passive debate can be divisive: you’re either one or the other. But both approaches have their strengths and weaknesses, which suggests that perhaps the answer is to create a blended approach.

For example, 2018-2021 was a tough period for value-oriented managers but 2022 showed the ugly side of a purely passive portfolio. Everyone agrees that timing markets is a fools' errand, but what if you leave a passive ‘core’ in place and supplement it with a valuation-focused active manager? This can help offset the Achilles heel of a purely passive approach of being fully exposed to the whole market as it becomes over-priced.

Importantly you can add as many managers as you like to your portfolio, active or passive, value or growth or something more contrarian. But it’s no use ‘diversifying’ across 10, 20 or 30 managers if they are all doing the same thing, with the same focus and holding the same stocks in their portfolios.

The key is to choose managers that have a compass that they stick to, staying true to their investment philosophy and process no matter what the market cycle throws at them. It may be painful at times, but you’ll know what you’re getting over the long-term, and each one can act as a diversifier for your overall portfolio because they are each doing something different.

… and valuation matters, too

In the latest 'Everything Bubble', growth stocks were the darlings of the markets, helped along by the money being pumped into the system by central banks in the wake of the GFC and the Covid-19 pandemic.

But now it appears that bubble is bursting, and more people are beginning to recognise that valuations matter.

Focusing on the broad market cycle misses something crucial - the cycle in valuation gaps, which can have just as big an impact on investor returns. Not all assets go up by the same amount during a bubble, and the same is true when that bubble bursts. This can lead to different experiences depending on what type of investment you’re in, whether it's the market darlings, or the unloved, boring businesses.

From a diversification point of view, this means it can be beneficial to build a portfolio from the bottom-up, focusing on fundamentals, rather than starting from a high-level top-down macro viewpoint. At Orbis, asset classes such as equities, bonds, commodities, and hedged equity all compete equally for space in our portfolios. We aim to select investments across asset classes to find those that will combine to offer the most attractive balance of risk and reward. By doing this, we end up with a portfolio that can be very different to the benchmark both on the equity and the bond side.

As contrarian investors we recognise that not everyone has the courage to stand above the parapet and potentially look foolish in the short-term, even when they know the long-term thinking is sound. But as a diversification tool, it can be powerful to have alternate viewpoints in a portfolio.

While it is a cliché, the old adage 'don’t put all your eggs in one basket' still holds true for investing. When you’re constructing a portfolio, the different baskets of risk and return should be truly different and robust enough to deliver a good balance of investment approaches that can weather any environment.

 

Shane Woldendorp, Investment Specialist, Orbis Investments, a sponsor of Firstlinks. This article contains general information at a point in time and not personal financial or investment advice. It should not be used as a guide to invest or trade and does not take into account the specific investment objectives or financial situation of any particular person. The Orbis Funds may take a different view depending on facts and circumstances. For more articles and papers from Orbis, please click here.

 

RELATED ARTICLES

Stars align for fixed income

The far-flung past as prologue

Chris Joye on why stocks and property are set for a poor year

banner

Most viewed in recent weeks

7 examples of how the new super tax will be calculated

You've no doubt heard about Division 296. These case studies show what people at various levels above the $3 million threshold might need to pay the ATO, with examples ranging from under $500 to more than $35,000.

The revolt against Baby Boomer wealth

The $3m super tax could be put down to the Government needing money and the wealthy being easy targets. It’s deeper than that though and this looks at the factors behind the policy and why more taxes on the wealthy are coming.

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

Are franking credits hurting Australia’s economy?

Business investment and per capita GDP have languished over the past decade and the Labor Government is conducting inquiries to find out why. Franking credits should be part of the debate about our stalling economy.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

The huge cost of super tax concessions

The current net annual cost of superannuation tax subsidies is around $40 billion, growing to more than $110 billion by 2060. These subsidies have always been bad policy, representing a waste of taxpayers' money.

Latest Updates

Superannuation

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

Superannuation

Less than 1% of wealthy families will struggle to pay super tax: study

An ANU study has found that families with at least one super balance over $3 million have average wealth exceeding $19 million - suggesting most are well placed to absorb taxes on unrealised capital gains.   

Superannuation

Are SMSFs getting too much of a free ride?

SMSFs have managed to match, or even outperform, larger super funds despite adopting more conservative investment strategies. This looks at how they've done it - and the potential policy implications.  

Property

A developer's take on Australia's housing issues

Stockland’s development chief discusses supply constraints, government initiatives and the impact of Japanese-owned homebuilders on the industry. He also talks of green shoots in a troubled property market.

Economy

Lessons from 100 years of growing US debt

As the US debt ceiling looms, the usual warnings about a potential crash in bond and equity markets have started to appear. Investors can take confidence from history but should keep an eye on two main indicators.

Investment strategies

Investors might be paying too much for familiarity

US mega-cap tech stocks have dominated recent returns - but is familiarity distorting judgement? Like the Monty Hall problem, investing success often comes from switching when it feels hardest to do so.

Latest from Morningstar

A winning investment strategy sitting right under your nose

How does a strategy built around systematically buying-and-holding a basket of the market's biggest losers perform? It turns out pretty well, so why don't more investors do it?

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.