Include Scarce Assets in Your Portfolio for Diversification

Money Bizwiz Team
2 Min Read

Understanding Productive and Scarce Assets for Better Portfolio Construction

When it comes to investing, assets and strategies typically fall into two main categories: productive and scarce. These concepts play a crucial role in portfolio construction and asset allocation, especially when considering major risk factors such as inflation and rates.

Productive assets are designed to finance and support productive activities in the economy, offering promised future cash flows. Equities and credit are examples of such assets, with returns linked to economic growth. On the other hand, scarce assets, like gold and high-end art, exist in limited supply and may not provide regular cash payments.

Measuring Productivity and Scarcity

While quantifying the supply curves of assets can be challenging, we can use statistical measures like coskewness to assess their convexity. Productive assets, like equities, tend to be concave, while scarce assets, such as government bonds and gold, are more likely to be convex. Understanding these traits can help investors navigate different market conditions and manage risks effectively.

Practical Applications

By combining both concave and convex assets in a portfolio, investors can achieve S&P 500-competitive returns with lower risk. Scarce assets are particularly valuable during recessions and inflationary periods, offering resilience and diversification benefits.

For example, a mix of stocks and bond duration in a traditional portfolio can provide a balance between productivity and scarcity. Including other scarce assets like gold can further enhance the portfolio’s risk-adjusted returns.

Conclusion

Understanding the dynamics of productive and scarce assets is essential for building well-diversified portfolios that can weather different market conditions. By incorporating assets with varying convexity profiles, investors can achieve better risk-adjusted returns and protect their investments from unexpected events.

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