Affairs, Scandals, and Greed: Why Portfolio Diversification Matters
Recent events in the technology sector remind us that even the best investments can be derailed by the people running them. Over the years, corporate scandals, poor decisions, and unexpected setbacks have destroyed significant shareholder wealth. Your financial security deserves protection from risks that can emerge without warning. Today, we explore the importance of diversification in investing and why it goes beyond simply owning more stocks. It's about protecting your portfolio from risks you cannot predict.
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The Human Element of Investing: When Trust Becomes a Financial Risk
As investors, we spend a lot of time analyzing financial statements, examining news about companies, and listening to interviews from management that outline their strategy and future plans. A company can have excellent assets, strong cash flows, and a very promising outlook. Yet, none of it guarantees the future trajectory of the company.
Interestingly, we classify our investments in tiers of risk, with some money saved for our speculative bets. The truth is that every investment has a certain level of speculation involved. We make bets that the future trajectory of the company would go a certain way, placing our trust in management to execute on their strategy. These decisions are made behind closed doors. As investors, we can’t access their transcripts or meeting minutes. We will have to trust that they are made in the best interests of shareholders.
Sometimes, the biggest threat to an otherwise excellent investment isn't competition, changing market conditions, or even excessive debt levels. It's the people entrusted with running the company.
Corporate history is full of examples of management misconduct, personal scandals, and accounting fraud that have destroyed billions in shareholder wealth. Financial statements or interviews could provide warning signs, but they are difficult to identify or interpret.
The Hidden Risks That Financial Statements Cannot Reveal
Enron: When Financial Statements Become Fiction
Enron Corporation, which was formed from the merger between Houston Natural Gas and InterNorth in 1985, was once considered one of America’s most innovative energy companies. The company initially set out to become a natural gas powerhouse in the U.S., then began to acquire overseas energy assets and ventured into a rather unrelated business of building fiber-optic networks, broadband communications, and even explored on-demand streaming via a partnership with Blockbuster.
Enron was a celebrated success story, named America’s Most Innovative Company by Fortune every year between 1996-2001, and recognized as America’s Best Companies To Work For. Eventually, management was found concealing a very different reality, shifting debts and losses from their books to related special-purpose entities, making the financial position appear stronger than it was. The accounting deception came to light in 2001, and Enron filed what was at the time the largest Chapter 11 bankruptcy in U.S. history, and contributed to the demise of Arthur Andersen, one of the largest accounting firms in the world.
2. Wells Fargo: When Management Incentives Go Wrong
In 1852, Henry Wells and William Fargo formed a company during the California Gold Rush to store gold dust, exchange for paper currency, and ship valuables. This company entered logistics with its network of stagecoaches and steamships, delivering mail, packages, and gold bars, and earned its reputation of being a reliable service provider. In the early 20th century, Wells Fargo split its banking operations from logistics and eventually evolved into one of America’s largest and most established banks.
Wells Fargo has consistently been rated as one of the World’s Most Admired Companies and Most Respected Companies. The bank has also secured the first spot in the Best Bank in the U.S. - Euromoney for four consecutive years, and ranked third for Management Quality by Fortune in 2015.
Just a year later, regulators exposed serious failures in management oversight, revealing that bank employees opened over two million potentially unauthorized deposit and credit card accounts. These were due to the aggressive sales culture and performance targets, and it was identified that employees transferred money between these accounts, opened accounts without customer consent, and manipulated customer information to meet sales quotas and earn bonuses. The scandal resulted in a $3 billion settlement in 2020, and demonstrated how business incentives and poor supervision encouraged misconduct and fraud
3. FTX: When Trust and Oversight Collapse
In 2019, Sam Bankman-Fried co-founded FTX, which quickly grew into one of the world's largest cryptocurrency exchanges. Bankman-Fried developed his image as a young financial prodigy, positioning FTX as a sophisticated platform known for advanced derivatives trading and high liquidity. The company attracted billions of dollars from investors, secured endorsements and partnerships with highly prominent celebrities and organizations. This is how FTX became one of the most recognizable brands in the crypto world, and Bankman-Fried was named among 27 individuals in Bloomberg’s first edition of New Economy Catalyst.
“For creating true impact at the cutting edge of technology and policy -- across borders, in emerging economies and beyond -- to build a more equitable and sustainable global future.”
But behind this impressive growth, Bankman-Fried and other members of the management team diverted billions of dollars in customer deposits to Alameda Research, his affiliated cryptocurrency trading firm, which used the funds to cover trading losses, repay loans, and make investments. Alameda was also given special privileges on the FTX platform, allowing it to withdraw customer funds far beyond what its available collateral would otherwise permit. When the cryptocurrency market weakened in 2022 and questions emerged about Alameda's financial position, customers rushed to withdraw their money, exposing the enormous shortfall. FTX filed for bankruptcy in November 2022, leaving customers and investors facing substantial losses. Bankman-Fried was subsequently convicted of fraud and other offenses and sentenced to 25 years in prison in 2024. The collapse demonstrated how misplaced trust in leadership, combined with weak internal controls and a lack of transparency, can destroy even a rapidly growing business.
Even the Best Investments Can Fail You
The examples above involve companies where misconduct and poor oversight ultimately came to light. But often, investors don't need to wait for outright fraud or a corporate scandal to lose money. Even an otherwise excellent investment can deteriorate because of decisions made by management, unexpected events, or structural changes in its industry, all of which cannot be anticipated even with the most comprehensive due diligence. We have all seen examples with:
A previously excellent management team starts making disastrous decisions.
A company becomes embroiled in an unexpected scandal.
An industry experiences a structural downturn that permanently changes its economics.
A company's business model becomes obsolete as technology or consumer preferences evolve.
Management takes on excessive debt, overextends the business, or pursues unrelated ventures.
Nvidia offers a timely reminder of how personal decisions at the top can create unexpected risks for shareholders. Jensen Huang co-founded and led Nvidia for over three decades, making it a dominant player in the semiconductor industry and the backbone of the AI revolution. Last week, Mr. Huang acknowledged an extramarital relationship with a business executive reportedly suspected by the U.S. federal authorities of having ties to Chinese intelligence. NVDA’s board has launched an independent investigation into whether their CEO was targeted by a foreign intelligence effort. As I write this, reports have surfaced that Mr. Huang has had an extramarital relationship with the company’s Vice President of Healthcare, Kimberly Powell.
The FBI investigation and a possible U.S. congressional subpoena introduce a new challenges for the company, while Mr. Huang’s alleged relationship with a subordinate created a situation where he could be fired. This morning, we wake up to the news that Jensen Huang has resigned, and the company's CFO will serve as interim CEO until a suitable candidate is identified. These developments have created an entirely new set of risks for investors, whose CEO has been closely associated with its success. This is also an important reminder that even the strongest businesses remain exposed to the judgment and personal decisions of the people running them.
At High Dividend Opportunities, our portfolio strategy involves a mental risk-management exercise that we fondly call “FBI Gut Check”.
“Imagine you wake up tomorrow morning, turn on the news, and see the offices of the company (or person) you just invested in being raided by the FBI—and it turns out to be a total fraud going to zero. How do you feel?
If your first course of action would be to get frustrated and panic over what will be a write off for an investment, then you likely invested too much into a single company. At HDO, we focus on diversification, because diversification is not an admission that you cannot identify good investments. It is an acknowledgment that you cannot control everything that happens after investing.
Diversification: Your Portfolio's First Line of Defense
It is safe to say that no matter how much research we do, we cannot eliminate every risk associated with an investment. We cannot control management decisions, prevent corporate scandals, or predict every structural change that might affect an industry. What we can control is how much of our portfolio we expose to any one of these risks.
This is where diversification comes in.
But diversification is not simply about owning more stocks. You could own 20 different companies and still have a poorly diversified portfolio if most of them are exposed to the same economic forces. Owning 20 energy companies does little to protect you if the energy sector experiences a prolonged downturn. Similarly, holding several companies that depend on the same commodity, interest-rate environment, or customer base may create an illusion of diversification while leaving your portfolio vulnerable to the same underlying risks.
Even the traditional 60/40 portfolio, with 60% allocated to equities and 40% to bonds, should not be mistaken for comprehensive diversification. While it spreads capital across two asset classes, both can experience losses under the same economic conditions. The current situation of persistent inflation and rising interest rates is a headwind for equity valuations and bond prices. True diversification requires looking beyond the labels of stocks and bonds and understanding the underlying risks, correlations, and economic drivers of each investment.
True diversification means spreading your investments across different companies, industries, asset classes, management teams, and sources of income. Each layer helps protect against a different type of risk:
Type of diversification | What it helps protect against |
Company diversification | Company-specific failures, scandals, and unexpected setbacks |
Sector diversification | Industry-specific downturns and structural changes |
Asset-class diversification | Different market and economic risks |
Management diversification | Poor decisions or misconduct by individual leadership teams |
Income-source diversification | Dependence on a single company, sector, or distribution stream |
Diversification is an insurance policy against the unknown and the unforeseen.
As an investor, you cannot eliminate losses or ensure that every investment will perform well. However, you can prevent any one company, management team, industry, or source of income from having an outsized impact on your financial future.
Two Sectors, Two Very Different Investment Environments
Diversification isn't about predicting which sector will outperform next. It's about owning businesses with different economic drivers so that your portfolio isn't dependent on getting one macroeconomic prediction right.
In that spirit, we will look at two sectors experiencing very different investment environments. The energy sector is benefiting from higher commodity prices, supply disruptions, infrastructure damage, and energy security concerns. On the other hand, REITs are facing headwinds from higher borrowing costs. These contrasting environments offer a useful illustration of why spreading investments across industries matters and how opportunities can emerge even when other parts of the market are struggling.
Mineral Royalties
Kimbell Royalty Partners (KRP) – Yield 12%
Kimbell Royalty Partners provides exposure to U.S. natural gas and oil production through mineral and royalty interests, allowing it to benefit from commodity prices without directly funding drilling operations. KRP recently reported record production of 27,565 Boe/d, with run-rate production reaching 28,910 Boe/d following its $221.2 million acquisition, more than nine times its IPO-era production. The partnership continues to grow through acquisitions while maintaining a diversified production base, with 45% of volumes coming from natural gas. KRP declared a $0.45/unit distribution, exceeding our estimate, and plans to maintain its policy of distributing 75% of distributable cash flow. With leverage at a manageable 1.5x debt-to-adjusted EBITDA and continued production growth, we believe KRP is well positioned to benefit from supportive energy markets, and view the recent share-price pullback as a buying opportunity.
2. Dorchester Minerals (DMLP) – Yield 12%
Dorchester Minerals is a Master Limited Partnership that offers a similar royalty-based model, generating distributions from oil and gas production across a diversified portfolio of mineral and royalty interests.
DMLP also reported a strong Q3, with operating revenues rising 4.5% YoY to $35.4 million and net income increasing 147% to $27.5 million. Higher realized oil prices, up 25% YoY to $70.33/bbl, helped drive royalty revenues, while the partnership declared a $0.8823/unit distribution, comfortably exceeding our expectations. DMLP recently expanded its royalty portfolio through the acquisition of 4,300 net royalty acres in the Williston Basin, funded through the issuance of additional common units. With no reliance on debt or commodity hedging, DMLP offers direct exposure to energy prices, albeit with greater distribution volatility. Assuming $80/bbl oil prices, we estimate a Q4 distribution of $0.73 to 0.75/unit, before any additional contribution from acquisition-related receipts and lease bonuses.
Real Estate
Kilroy Realty Corp (KRC) – Yield 6%
Kilroy Realty Corp (KRC) just delivered its strongest leasing quarter since 2019, signing over 800,000 sq. ft. of leases and bringing year-to-date leasing volume to 1.75 million sq. ft., up 44% YoY. Portfolio occupancy remains weighed down by its unoccupied KOP2 life sciences campus, but excluding that property, occupancy stood at 80.7%, with another 1.4 million sq. ft. of signed leases awaiting commencement and representing $101 million in annualized base rent. New leases achieved attractive cash rent increases, while management tightened its full-year FFO guidance. With an investment-grade balance sheet, ample liquidity, and improving leasing conditions across its technology-focused markets, KRC offers an opportunity to participate in an office-market recovery, although vacancy and the delayed ramp-up at KOP2 remain important near-term headwinds.
2. Realty Income (O) – Yield 6.1%
Realty Income (O) continues to demonstrate the resilience of its diversified net-lease business, ending Q3 with 15,536 properties, 98.8% occupancy, and an 8.5-year weighted-average remaining lease term. The largest net-lease REIT in the world invested $2.2 billion in acquisitions during the quarter at an initial cash yield of 6.8%, while same-property leasing activity achieved a healthy 103.5% rent recapture rate. AFFO per share increased 3.7% YoY to $1.12, prompting management to raise its full-year guidance to $4.45 to 4.46/share. With an investment-grade balance sheet, a 6.1% dividend yield, a 30-year track record of annual payout increases, and a conservative 73.2% AFFO payout ratio, Realty Income offers a compelling combination of recurring income, diversification, and steady dividend growth.
Conclusion
We cannot predict every market downturn, corporate setback, or unexpected event. But we can build portfolios that are better equipped to withstand them.
At High Dividend Opportunities ,we maintain a diversified portfolio of more than 40 income-producing securities, spanning real estate, energy, commodities, telecom, technology, banking, preferred shares, and baby bonds. At any given time, some holdings are performing well while others face challenges. Together, they generate a steady stream of income designed to support our lifestyle across different market conditions.
Ultimately, diversification is not about finding investments that always go up together. It is about ensuring that no single company, industry, or management team has the power to derail your financial future. This is the beauty of our Income Method.
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