Skis and Bikes: The Untold Story of Diversification

Skis and Bikes

In most parts of Canada we have very distinct seasons. Some months of the year are temperate and relatively dry, while other months are cold and snowy. As a result, most Canadian towns of any size have stores that sell skis and bikes. Of course, they don’t inventory both skis and bikes at the same time. Rather, in the spring they sell off all their ski related inventory and set out their bike gear, and in the fall they clear out the bike gear to make room for skis. Pretty creative, right? Let’s observe a simplified example of bike sales and ski sales over several years.

Figure 1. Sales of skis and bikes

Source: ReSolve Asset Management. For illustrative purposes only.

As winter approaches, ski sales accelerate while bike sales drop off. As summer approaches people stop buying skis, but ramp up their purchases of bikes. One line of business is thriving while the other is flat. In some years, winter might come late and produce very little snow, stifling ski sales.

But the subsequent spring might be warm and dry, and encourage bumper bike sales. This is the nature of diversification.

This same effect plays out in markets. Economic news that is good for one type of investment is often bad news for another. In fact, the hallmark of a diversified portfolio is the observation that one or more investments is disappointing you most of the time. 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.