For example, big demographic shifts have the potential to shift bond/equity correlation. Millennials, the largest demographic group, we have seen to date, tend to stay out of more risky assets which overtime may impact both the value and correlation of these two asset classes assuming millennials have a large enough portion of investable assets. An article in Institutional Investor highlights that millennials, those born 1980s and later, are the most conservative group of investors financial advisers have recently seen with nearly half keeping most of their portfolio in cash or treasuries.
Second, fear and uncertainty caused by large market shocks exerts simultaneous downward pressure on all assets and increases correlation (see asset correlation post 2008 crisis). In other words, in situations where investors most need the impact of diversification, such diversification is most futile. An extreme example of that would be a run on the banks like the one experiences during the Great Depression, and the desire to keep any wealth “in cash under the mattress.”
The following graph presents when various markets hit their maximum draw down point (between 2007 and 2013) relative to the size of the draw down (Source Seeking Alpha)
Not only did equity markets hit bottom during the global credit crisis and within a six-month window from October 2008 to March 2009 but also the trend extended to typically uncorrelated assets – commodities, well-known absolute return mutual funds, hedge funds, and even most fixed income sectors. A traditional static long-only portfolio would not have protected investors at that point.
How can investors accomplish diversification:
The typical 60%/40% portfolio is unlikely to deliver true diversification in an economic environment that is more varied and unpredictable than in recent decades. Investors need to look further at a broader actively managed portfolio mix of both public and private securities. An alternative approach is to construct a multi-strategy platform of targeted macro driven investment strategies that incorporate insight from an economic, political and social perspective. Such a portfolio incorporates not only publicly traded assets such as stocks and bonds but also private holdings including real estate, private equity and venture capital that require management and operational expertise to deliver alpha.
Read this article on Forbes.