The End of Diversification?
Recent years there has been a shift in how various assets classes are trading. There is emerging a high degree of positive correlation among various financial asset classes that have many concerned since it is not conforming with the perceived historic norms. Many are reading into this as a warning of what is to come. When different asset classes move in the same direction simultaneously, this obviously eliminates the theory of diversification is asset allocation.
Asset allocation over the years has been the way portfolios are arranged because they lack the ability to forecast the major trends. The belief has been that the possible benefits of diversification across classes reduces risk and offers a management tool knowing that you will lose on one side but win on another class.
When there is a high correlation between classes, these asset allocation models fail. The concerns become that this injects a negative development because they fear if one asset class falls, it will take all of the others with it.
What is being overlooked here is the fact that there is a major shift underway which is not understood and this creates the risk of a LIQUIDITY CONTAGION whereby a loss in one asset class causes liquidation in all others to raise cash to cover the losses in one particular asset class. Welcome to the new age of international contagion which is far more serious and cannot be reduced by simply diversification.
We will be looking at establishing a Webinar for Institutional Clients on this subject matter.
