The relationships that made asset allocation an effective way to diversify have changed. Correlations between most asset classes have been creeping steadily upward since the mid-1990s. By early 2008, most asset classes were moving significantly in step with the S&P 500. By the fall of that year, at the peak of the credit crisis, correlations spiked further and asset classes of nearly every kind (with the exception of safe-haven treasuries) experienced severe losses. Many studies have pointed to the fact that in a typical ‘balanced’ portfolio of 40% bonds and 60% equities, more than 90% of the portfolio risk comes from equities, during normal markets. Naturally, during crisis periods when correlations spike, that number is even higher.
This is an excerpt from our article “The Asset Allocation Merry-Go-Round” published December 16, 2011