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There’s a saying on Wall Street that the only thing that goes up in a market crash is correlation. In lay terms, it means that “non-correlated” assets—that is, assets that are supposed to move in opposite directions to reduce a portfolio’s volatility—might suddenly move down together in extreme circumstances.
That was certainly the case during this market crash. Nearly every asset class, whether it was bonds, stocks, real estate, or commodities, lost value. Many people have interpreted those results to mean that diversification doesn’t work.
One or two asset classes (I debated whether or not I should have put “asset class” in quotes) did make money. And you better believe those who manage them are letting people know about it. Managed futures are one example. Managed futures are run by commodity trading advisers who buy and short futures contracts for all sorts of asset classes, like commodities, stock indexes, and currencies.
Their returns for the last several years have been ridiculously good. On average, they beat the stock market by 51% last year, according to one index. I’m not too familiar with managed futures, but a columnist with the Wall Street Journal does a good job explaining why it might not be a good idea to jump into them based on their recent performance.
I would extend that warning to anyone looking for new asset classes to add to his portfolio and prevent drops like we saw last year. For one, it’s never a good idea to invest in something you’re not familiar with. Second, the factors that helped the new asset offset the losers might not be there next time, as the Journal columnist argues. But finally, ask yourself if diversification truly “didn’t work” last year.
Yes, corporate bonds lost money along with stocks, but they didn’t lose nearly as much. In fact, if you had simply invested in a total bond market fund (of which nearly a quarter would have been Treasury bonds) your fund would have made a few percentage points.
My feeling is that in times like last year, you’re likely to lose a substantial amount of money no matter how many asset classes you spread your investments in. If you want to earn a return above what cash equivalent investments give you, you’ll always have to take on risk. A new asset isn’t going to fix that.
— Joe Light