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Diversification Performance and Stress-Betas

Martin L Leibowitz and Anthony Bova
The Journal of Portfolio Management Spring 2009, 35 (3) 41-47; DOI: https://doi.org/10.3905/JPM.2009.35.3.041
Martin L Leibowitz
is the managing director of Equity Research at Morgan Stanley in New York, NY.
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  • For correspondence: martin.leibowitz@morganstanley.com
Anthony Bova
is the vice president of Equity Research at Morgan Stanley in New York, NY.
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  • For correspondence: anthony.bova@morganstanley.com
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Abstract

In earlier research, the authors found that, on both a theoretical and historical basis, the typical diversified fund exhibits volatility characteristics that are strikingly similar to a traditional 60/40 allocation and, in severe market declines, should theoretically underperform the 60/40 portfolio. This latter and surprising result is due to the stress-beta effect that derives from diversification because the multiple asset classes are more vulnerable to correlation tightening than the two-asset 60/40 allocation. The year 2008 provided an (unwelcome) opportunity for the authors to test this stress effect. They found that in 2008 the diversified portfolio's correlation-based beta was, in fact, much higher than in normal times and that 2008 was the first period in which the diversified portfolio performed materially worse than the 60/40 portfolio. Thus, the typical model of institutional diversification should be viewed not as reducing risk in the short-term, but rather as a source of longer-term benefits in the form of greater return accumulation and wider divergence of outcomes.

TOPICS: Portfolio construction, accounting and ratio analysis, financial crises and financial market history

  • © 2009 Institutional Investor, Inc.
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Vol. 35, Issue 3
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Diversification Performance and Stress-Betas
Martin L Leibowitz, Anthony Bova
The Journal of Portfolio Management Apr 2009, 35 (3) 41-47; DOI: 10.3905/JPM.2009.35.3.041

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Diversification Performance and Stress-Betas
Martin L Leibowitz, Anthony Bova
The Journal of Portfolio Management Apr 2009, 35 (3) 41-47; DOI: 10.3905/JPM.2009.35.3.041
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  • Article
    • Abstract
    • THEORETICAL BETA-BASED RISKS
    • HISTORICAL RISK CHARACTERISTICS
    • ALPHA AND BETA RETURNS
    • STRESS-BETA THEORY
    • 2008 RESULTS AND STRESS-BETAS
    • CONCLUSION
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