For & Against: Does diversification still work?

This means that although it may currently be more difficult to find asset classes with negative correlations, I believe it is still possible to find asset classes with low correlations, and that is likely to prove to be advantageous.

All investing is fundamentally about the trade-off between risk and reward; you need to accept enough risk to achieve your desired returns but not so much that you stay awake at night worrying.  

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Whatever anybody says, for me diversification remains key to managing risk.

Against: Mark Polson is principal of the Lang Cat

I will start this off by noting that just as Brandon Flowers once sang that he had soul but he was not a soldier, I have got higher economics and have not got a clue about macro-economics in 2019.

Nonetheless, there are some things going on that are worrying me a bit, and none of the people I have asked who understand more than me have been able to allay my worries.

A fundamental tenet of portfolio construction for decades has been the equity-bond correlation – as equity prices rise, bond yields also rise, reflecting a decline in their price.

To put it another way, equities and bonds tend not to tank at the same time, and so bonds act as a great diversifier to equities in portfolios.

This accepted wisdom is reflected in virtually every centralised investment proposition I see, where a predetermined split of (usually) large-cap equity allocations is gradually reduced as you go down the seven or 10 risk grades in favour of (usually) investment-grade bonds.

Again, this reflects decades of experience, and so it must be right, right?

Well, maybe not. In the first quarter of 2018, equities and bonds fell in unison – the traditional correlation was reversed. This freaked the life out of the investment industry, and continues to do so.

The change in correlation – in the United States at least – appears to be continuing, for reasons that clever people argue over.

Now, I do not know if that change in correlation will affect advisers’ model portfolios or not. But what I do know is that most advisory models I see work in the same way, with roughly the same increases in bond exposure as you go down the risk spectrum. The bond funds people buy tend to be commonly held, and all in all it all looks a bit samey.

That is fine if the old correlations hold true. But what if they do not?

If everything heads the same way at the same time – as it did a decade ago – we are looking at a change that will fracture the way portfolios are built in retail intermediated investment.