Loss of Diversification

One of the more disturbing market issues we have been watching over the past 6 months has been the reduction in diversification benefits between bonds and shares, as well as across borders. Under normal market condition we expect bonds to do well when shares are falling and vice versa. As shown in the table below, as all asset prices around the world are all pushed higher in the hunt for yield, shares and bonds have started to become much more correlated, meaning they are moving in a similar cycle, and hence we can expect to see this correlation hold should the share and/or bond markets suffer losses.

Similarly we expect to receive diversification benefits from investing in different countries, but as correlations between countries continue to climb we are losing this as well.

This loss of correlation will potentially have a large impact on volatility in returns of more normal portfolios, but is something that we are managing within our clients’ portfolios via the use of high conviction, benchmark unaware managers, who can move to cash in times of high market stress.

Bond/Equity Correlation

correlation1

US S&P500/Shanghai Composite

correlation2

Source: Bloomberg.com