The New Diversification: Open Your
Eyes to Alternatives

Abstract

During the 2008 financial crisis, many portfolios considered widely diversified failed to fulfill their expected function of protecting against large drawdowns. Historically, correlations among various types of stocks and bonds have usually increased during financial shocks, but the diversification shortcomings of standard portfolio allocations still surprised investors. Six years later, managers have a more sophisticated understanding of portfolio drawdown risk and how to mitigate it through diversification. In this article, the author advocates a focus on the risk exposures within a portfolio and inclusion of risk diversifiers—often sourced through so-called “alternatives”—to design portfolios more resistant to volatility spikes and major shocks.

TOPICS: Financial crises and financial market history, portfolio construction, in portfolio management