When Diversification Fails

Sébastien Page and Robert A. Panariello

Financial Analysts Journal, 2018, vol. 74, issue 3, 19-32

Abstract: One of the most vexing problems in investment management is that diversification seems to disappear when investors need it the most. We surmise that many investors still do not fully appreciate the impact of extreme correlations on portfolio efficiency—in particular, on exposure to loss. We take an in-depth look at what drives the stock-to-credit, stock-to–hedge fund, stock-to–private asset, stock-to–risk factors, and stock-to-bond correlations during tail events. We introduce a data-augmentation technique to improve the robustness of tail correlation estimates. Finally, we discuss implications for multi-asset investing.Disclosure: The views expressed in this article are those of the authors and do not necessarily reflect the views of T. Rowe Price. Details can be found at the end of this article. Editor’s Note Submitted 7 November 2017Accepted 23 February 2018 by Stephen J. BrownViews expressed by the authors', are subject to change without notice, and may differ from those of other T. Rowe Price associates. Information and opinions are derived from sources deemed reliable; their accuracy is not guaranteed. This material does not constitute a distribution, offer, invitation, recommendation, or solicitation to sell or buy any securities; it does not constitute investment advice and should not be relied upon as such. Investors should seek independent legal and financial advice before making investment decisions. Past performance cannot guarantee future results. All investments involve risk. The charts and tables are shown for illustrative purposes only.

Date: 2018
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DOI: 10.2469/faj.v74.n3.3

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