Modern Portfolio Theory suggests that risk can be reduced through diversification. Euphemisms such as don’t put all your eggs in one basket have been prevalent in society for generations, but only within the last several decades has there been enough data and computing power to scientifically and mathematically support the benefits of diversification for investing.
There are financial life hacks in many religious tomes. I recently heard Dr. Daniel Crosby cite Ecclesiastes 11:2 which states, “Invest in seven ventures, yes, in eight; you do not know what disaster may come upon the land.” This type of information has been suggested colloquially long before we ever heard of a Sharpe Ratio. Despite all the tools and information, we have at our disposal the one constant in investing is our humanity.
Cattle farmers have practiced the features of diversification in their pastures for millennia as well. Having to combat the uncontrollable factors of life such as drought, mud, snow, heat, flies, etc means that farmers adapt to and work with what mother nature throws at them to the best of their ability.
Celebrity farmer and local food statesman Joel Salatin wrote a book called “Salad Bar Beef,” that discusses his style of cattle farming, which he entertainingly describes, as “Mob stock omnivorous solar conversion liquified carbon sequestration fertilization.” (video in the link)
There’s a lot to unpack in that description, but what the title of the book points to is the grasses, legumes (clovers), and forbes (aka weeds) represent diversity in a pasture when it is managed holistically. Pastures managed like this may not be the most manicured horse-country fields ever seen.
Cattle enjoy a polyculture diet rather than a monoculture, but the diversity also works with the season and weather. Species diversity in the pasture can serve homeopathic purposes as well for the cattle and allows them to eat the preferred plant in that specific time and place.
My farm’s location in Charlottesville is in the Fescue Belt. Fescue grass forms the backbone of the pasture in most cases throughout this region. The upside of this is the opportunity for winter stockpiled grazing, a dense sod to hold up to wet periods, and both a Spring and Fall growing season. The downside is that fescue tends to form monocultures when the pasture is grazed short or hayed and has a toxin that raises the core temp in cattle which is problematic if you’re in breeding season.
Pasture and soil health, which many progressive farmers are now focusing their attention on, benefit from having a growing root in the ground at all times. Farmers also benefit from having warm season grasses growing when their cool season grasses are shutting down in high temperatures.
Johnsongrass is considered an invasive species so it’s illegal to plant and your neighbor may give you the stinkeye if they see it near their place. It can release cyanide when it is stressed through drought, mowing, or most commonly frost. However, it also is a perennial that is related to corn and can grow dramatically in the heat. I inadvertently grew two pastures of it on our river bottom by making hay which reduced competition in early July several years ago. The cattle loved it! It is not possible to grow that type of forage in the summer under normal circumstances without a lot of effort and money.
Managing the pasture to work with the season and pasture species present diversifies your forage base. A drought shuts down growth, but a species like Johnsongrass continues building biomass. Having a diversified pasture is critical to farm profitability. 60 – 70% of a cattle farmer’s expenses are for providing stored feed. The response to not having enough forage during a drought could mean a herd liquidation when prices are depressed or purchasing feed at a high cost because other producers are doing the same to address their crisis.
Similarly, investors protect from portfolio drawdowns and the type of bad behavior reactions those cause through diversification. Long periods of time in the market is more important than timing the market.
The chart below from Vanguard shows the returns of the S&P 500 in the shaded area and volatility in blue. Volatility, which some view as risk, increases the likelihood that an investor will abandon their plan during a drawdown and not receive the anticipated return.
Investors can increase the likelihood of achieving returns similar to the market by investing in a portfolio that smooths returns. The chart below from Michael Batnick shows an interesting comparison between the S&P 500 and a 60% (stocks) with 40% (bonds) allocation.
If an investor is more likely to stick to a more conservative portfolio they may achieve higher returns then they could at an individual level despite what the market performance indicates. Many investors achieve annual returns several percentage points below the stated performance of their funds from poorly timed activities which are mainly due to selling low and buying high.
Again, Vanguard found that portfolios that were broadly diversified had a better chance of outperforming their benchmark the more diversified they were. Many investors think that concentrated bets improve returns however, the chances of those bets being right are what reduce the probability of outperformance.
Vanguard found that market returns were driven by owning the very few most successful stocks. Increasing the odds of owning those stocks through more holdings increased the chances of achieving at least market returns.
The primary goal of farms that consider themselves going concerns is to maximize profitability over the long-term and limit short-term catastrophic drawdowns. If we view another graphic demonstrating the growing seasons of cool season and warm season grasses and consider the goal of reducing our feeding costs the benefit of seasonal pasture diversification is evident. Working with mother nature to maximize efficiency by allowing the pasture to capture as much rainfall and solar energy as possible is beneficial to the farm ecosystem’s soil health and its livestock.
Investors have similar investment return goals that have frequently been achieved through similar methods of controlling costs, taxes, and arbitraging human nature. Diversification’s investment smoothing and the rotating performance of different assets classes gives investors a better chance of achieving their goals. Next time you look at a pasture, remember that diversity in the field is good for the animals, soil health, and the farmer. So go ahead, diversify your perennial pasture portfolio. I’ll be doing the same.