Canadian Weather Patterns: A Lesson in Diversification

27 Nov Canadian Weather Patterns: A Lesson in Diversification

Over the past couple of months, the markets have encountered a fair amount of turbulence. What was forecasted to be a period of calm and pleasant economic growth was instead replaced with a torrid spell of volatility and confusion, which leads us to our next story.

The coldest weather conditions in Canada are generally found in Yukon, the Northwest Territories and Nunavut, where temperatures regularly dip to -30 ℃. Most parts of the country experience relative dry weather for a few months of the year but the moderate weather conditions ultimately give way to perishing cold.

As a result of the varied conditions, Canadian towns situated near or on mountains cater for a multitude of adrenalin-fuelling pursuits, the most popular of which are mountain biking and skiing.

Given the lack of similarity between the two types of equipment required to perform each sport, local equipment shop must maintain stock effectively and so manage their stock in line with the weather cycle. Stores frequently sell all remaining bike related inventory in the fall, in preparation for high demand of skis in the cold months. And in the spring, they sell off all their ski related stock to make room for the increase in demand for biking equipment in the summer.

The chart below illustrates the average monthly sales of bikes and ski related stock, as well as the overall sale of a typical store over several years. As you can see, when bike sales zig, ski sales zag, but the combined sales of the items create a fairly smooth sales curve.

Source: ReSolve Asset Management. For illustrative purposes only. 1

If you’re thinking to yourself: ‘I neither ski nor do mountain biking, what’s this got to do with me?’, this analogy illustrates the power of diversification.

A prudent investor holds a diversified portfolio that includes main stream asset classes such as equities and bonds. When equities have a difficult period, bonds tend to fair better, and vice versa, much like when mountain-side stores tend to sell more bikes when ski sales are doing poorly.

As Canadian investment manager Adam Butler notes, the hallmark of a diversified portfolio is the observation that most of the time one or more of your investments should cause you disappointment. A portfolio that consists of assets that all produce gains at similar times for similar reasons will probably produce their worst losses at the same time too.

Investment writer Nick Murray once wrote ‘diversification is virtually a character trait. It is a way we manifest humility—our confession that, although we have a very good idea what’s going to happen in the long run, we never know what’s going to happen next. Nor does anyone else; the difference is we admit it.’

1 Credit: Adam Butler, CFA, Michael Philbrick and Rodrigo Gordillo: Skis and Bikes: The Untold Story of Diversification