A prudent investment strategy usually stresses diversification because no one knows when a single stock, industry, or entire financial asset class will tank.
A very typical investment portfolio will have a mix of both stocks and bonds, like Treasury bonds. Investors count on this mix because when stocks tank, that money often flows into bonds, sending prices in those markets higher.
However, that relationship hasn’t held in some recent bouts of market volatility.
“Looking at two recent episodes of market volatility, the taper tantrum of 2013 and the September setback of 2014, we discover a troublesome commonality,” Columbia Management’s Jeffrey Knight wrote. “During both of these events, nearly the full array of asset classes posted negative returns.”
In other words, diversification didn’t really work.
During periods of crisis, it’s not unusual to see investors liquidate everything. However, no one would characterise the sell-offs Knight refers to as crises.
“While these two episodes proved to be only temporary, we think they foreshadow the risk management challenge that investors face when so many market prices are connected by interventionist macro policies,” Knight said. “If all assets can rise together, then surely they can fall together.”
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