Return vs Diversification: What Matters More?

The more diversified, the lower the return expectation

May 2026. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

• Diversifying strategies do not need to feature high returns
• Lower correlations are more valuable than higher returns
• Low correlations are preferable to negative correlations

INTRODUCTION

Almost every investor desires higher returns and is willing to bet on active fund managers to achieve these. However, most fund managers fail to beat their benchmarks, making this an expensive fool’s game for most investors. If the returns of the S&P 500 are not high enough, why not simply buy a leveraged version of it?

The ProShares Ultra S&P 500 (SSO) aims to deliver 2x the returns of the S&P 500, but investors have entrusted it with only $7bn in assets. In contrast, the State Street SPDR S&P 500 ETF Trust (SPY) manages $700bn. Given all the performance chasing, the total assets in leveraged ETFs in the U.S. are estimated to be less than 1% of the entire stock market, which is surprisingly low (read Outperformance via Leverage).

Naturally leveraged ETFs have inherent weaknesses, such as high fees and negative compounding due to daily resets. However, SSO has generated a CAGR of 15.3% vs 11.2% for SPY over the last 20 years. Using leverage also implies that there is more capital available for diversifying strategies, as the equity allocation can be reduced (read 60/40 vs Leveraged Diversified Portfolio).

One question that frequently arises is how high the return expectations for the diversifying strategies should be, which we explore in this article.