Diversification versus Diworsification; American Education as an Exercise in Capitalism*

Diversification versus Diworsification

Diversification is a means of wealth preservation that spreads investments among a range of assets and asset classes. It relies on the concept that owning different kinds of financial assets is less risky than owning only one type and requires an investor to accumulate assets with varying correlations, thereby reducing risk and minimizing the negative effect any one asset or asset class might have on portfolio performance. In short, diversification is a means of preserving and enhancing wealth while minimizing risk. Its key insight is that an asset’s risk and return should not be assessed in isolation, but by how it contributes to a portfolio’s overall risk and return. Diversifiers structure their portfolios to perform well in a variety of market conditions. In so doing, they enhance performance in up and down markets. They often rely on Modern Portfolio Theory, a formalized method for diversifying portfolios.

Diworsification is a term used to describe investors who seek a more aggressive risk-reward profile characterized by a highly concentrated portfolio. Those who disdain eschew diversification in favor of concentrated bets are often called Concentrators. They believe that Diversification dilutes returns and is an over-used and inefficient method of wealth maximization. They flip the terminology by treating Diversification as a “worse alternative” – that is, Diworsification. Concentrators believe that Diversifiers dilute their returns by spreading their investments too broadly. They believe in a narrower asset focus and concentrate their investments in a specific sector, whether rental real estate or Apple equity or Tesla bonds or subprime mortgages or tulip bulbs. Concentrators accordingly believe in the obverse of Modern Portfolio Theory. They are greater risk-takers. If they are correct in their projections of future economic events, their investments outperform a diversified portfolio … that is, they get rich(er) quick(er). Because of the greater risk inherent in a concentrated portfolio, if they’re wrong – if the markets or their asset class hit a wall –, they lose a substantial portion of their investment capital … that is, they get poor(er) quick(er). Concentrators who invest on a leveraged basis – whether through margin borrowings or otherwise – frequently find themselves wiped-out.

Unlike Diversifiers, in order for Concentrators to be successful they not only must select assets that outperform. They also must correctly time both the initiation and liquidation of their investments. A successful Concentrator accordingly has to be prescient in discerning an outperforming investment opportunity, capable of determining how and when to make the investment (as well as when and whether to increase the investment), and opportune in timing a propitious exit. Extremely few investors are can be that smart. Many end up bankrupt … a relatively few are successful, recognize their luck and don’t attempt to press it … and a rare few are able to repeat and amass huge(r) wealth. The very smartest Concentrators, however, understand this from the beginning and therefore hedge their bets – they separate their educated gambles from their diversified portfolios.

A notable example of a successful 21st Century Concentrator Diversifier Concentrator-Diversifier is John Paulson, who made what has been called The Greatest Trade Ever (the title of a book by Gregory Zuckerman) when he shorted subprime mortgages prior to the 2008 financial crisis. He executed his short through a segregated fund he had organized for this purpose, while separately maintaining a diversified portfolio. He therefore gambled with risked only a relatively small portion of his personal, hard-earned wealth to make the bet concentrated investment.

One problem that confronts Concentrators is the random reinforcement faced by all gamblers risk-embracing investors. Concentrators’ investment bets are equivalent to bets placed in Las Vegas, sometimes with a comparable risk-reward profile. That profile differs greatly from the profile of a Diversifier. A Diversifier recognizes that luck plays a significant role in market timing and therefore structures an investment portfolio to perform well in good markets and bad. Concentrators persuade themselves that their bets investments are being made with a high degree of certainty, that their timing has been finely tuned, and that they will know when best to exit the concentrated investment. Should they have success, they conclude that a repetition not only is likely but inevitable, and they sometimes then ignore the risks. Paulson was right in making his bet in 2008. Had he made the same bet in 2002 or held onto the same investment until 2012, no one would have written about The Greatest Trade Ever. Timing isn’t merely the most important thing in a concentrated investment portfolio. It’s often everything.

American Education as an Exercise in Capitalism

The goal of America’s public education system is to prepare students for adult life by providing them with the tools necessary to achieve financial, social and civic success. Doing so requires providing children with the highest quality education at the lowest possible cost. In reaching for that goal, school systems are supposed to use their best efforts to deliver access to programs that are consistent with each student’s needs and abilities. Although there are differing opinions of what precisely comprises a “high-quality education” – for example, the weight to be accorded to jobs skills and to economic skills –, there is consensus that each is a necessary component.

Betsy DeVos, the U.S. Secretary of Education, is a strong believer in a form of laissez-faire educational capitalism that includes freedom of choice for those who wish to open chartered public schools. “Charter schools are great options for thousands of students, and the demand for more of them remains very high,” DeVos said. “We need more ….” Her view is controversial given the mixed performance of charter schools, even with charters enrolling only 6{29ea29b64b10057f61377b2c087cd5b7537a0cd24da4295a308b0bf589469f35} of the nation’s public school students. (DeVos also advocates Federal vouchers for public and private school education, a more controversial question with a different analysis that would include whether the government should support private enterprises (here, educational ones) and Constitutional questions about subsidizing religion.)

The original concept for charter schools was to allow citizens, whether teachers or parents, to develop their own ideas, with Federal funding giving them the ability to pursue those ideas. Charter schools therefore were intended to serve as disrupter-alternatives – giving parents the choice of sending their children to local public schools or to publicly-chartered ones that may not be so local. The amount of Federal funding allocated to each of those schools, whether public or charter, is based on enrollment and therefore creates a quality contest that allows parents to select the school that both has the best relative performance record and best fits their child’s needs. Those schools providing the best education are intended to be the winners (and accordingly to receive the most funding) and those that do not live up to their potential are to be the losers … and are forced to close because they fail to attract an adequate student population. In short, the goal is survival of the educationally fittest – quintessential capitalism.

Unfortunately, it hasn’t been that simple, in large part because the incentives in publicly-funded education have not been properly aligned and there is little or no oversight of charter schools or their curricula. Charter schools for the most part are independent and therefore not subject to the transparency obligations of State and local governments. Their ultimate owners are individuals who have different motivations for seeking chartered schools. All obtain their school charters from State or municipal governments that often fail to carefully review their capabilities, expertise or track record … and yet all such chartered schools receive monies on a per-student basis (initially based on superior advertising purely on promises). They then use those Federal monies to build/rent schoolrooms (sometimes from affiliates), pay teachers (whose credentials are determined or not by the charter) and provide students with whatever materials they decide are appropriate (including religious materials that may stretch or exceed Constitutional limits) … as well as potentially retain a portion for themselves as profit. An example of the potential consequences of vague charter school policies compromises reached in chartering schools is a school that supplemented low teacher pay with parental donations that enabled its owner to pocket millions of taxpayer dollars … and yet was highly-rated for its educational achievements.

School choice has created strange bedfellows among Republicans and Democrats. Both Parties initially favored them on a bipartisan basis, though for different reasons. Today, most Republicans favor funding all charter schools, including the same inner-city charters they once opposed, while many Democrats now are more skeptical of those same schools, some because of issues raised by local teachers’ unions. To their credit, charter schools’ remit includes acting as a catalyst for the break-up of cronyism in local government hiring, which has the potential to improve local educational governance. Another strength of charter schools is to provide a publicly-determined record of success and failure, the latter particularly helpful in targeting mismanaged schools. Poorly-managed schools more often are found in poorer neighborhoods where minority parents are eager for better educational opportunities … and where sending their children to charter schools has resulted in higher test scores, enhanced opportunity and improved lives. These aspects of charter schools cause disruption, which has its boosters and its detractors … again in both Parties and for different reasons.

The performance record of charter schools is, to say the least, mixed. School choice has failed to deliver on its promise of improved education in many States and localities (including DeVos’s home state of Michigan) and succeeded in others (including Newark, New Jersey). Various explanations have been offered for the dichotomy. One is that urban charter schools create an enhanced competitive environment that improves overall educational and administrative quality, while rural charter schools more often siphon off existing students for personal or religious reasons and thereby do not improve overall test scores or educational opportunities. Another is that doling out Federal monies should not create an unbalanced economic incentive where education is not the clear winner … similar to the economic incentive that led to the Savings and Loan Debacle of the 1980s where those who received Federal support found that Federal legislation filled their pockets without obligating them to deliver public benefits. Today, monies are distributed by the Federal government for educational programs mandated by State and local governments … frequently without oversight. In order to fulfill the goal of disrupting and improving a public education system designed for a prior century era, State and local governments need to take an activist role in monitoring and, when necessary, reorganizing public schools that fall behind a rising curve … and, if charter schools are not contributing to that rise, to impose higher charter school benchmarks as well.

In the past, concerns about public school education in America often were met, unsuccessfully, with rigorous government regulation. More government oversight and the clear setting of rising educational performance benchmarks clearly would be beneficial. Improving the education of America’s children – preparing them for the future – should top the list of America’s priorities. (American children currently rank in the middle on international test scores in science, math and reading. To quote one media analysis, “U.S. students’ academic achievement still lags that of their peers.”) Doing so should be a focus of Federal, State and local officials – that is, of those who have been charged with and made responsible for the essential task of improving American education.

Finally (from a good friend)

The English language has some wonderfully anthropomorphic collective nouns for the various groups of animals.

We are all familiar with a Herd of cows, a Flock of chickens, a School of fish and a Gaggle of geese.

However, less widely known is a Pride of lions, a Murder of crows (as well as their cousins the rooks and ravens), an Exaltation of doves and, presumably because they look so wise, a Parliament of owls.

Now consider a group of Baboons. They are the loudest, most dangerous, most obnoxious, most viciously aggressive and least intelligent of all primates.

And what is the proper collective noun for a group of baboons?

Believe it or not ……. a Congress!

I guess that pretty much explains the things that come out of Washington


*┬® Copyright 2019 by William Natbony. All rights reserved.

1 Comment
  • Dennis Draizin
    Posted at 11:09h, 08 June

    Bill, I am a new fan of thelonelyrealist.com. There is much to learn and think about in your blog. How about that Congress? ( American Nurse Today 07/09/2013 and Miriam Webster Dictionary). How did you find it. The Oxford dictionary calls a group of baboons a troop. Also fitting for our representatives who seem to be in a perpetual state of war. Liked the joke about the wealthy lawyer. Appreciated your advice on the dangers of over concentration of assets.

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