Quick Clips: What’s the Worst That Should Happen?

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Quick Clips: What’s the Worst That Should Happen?

While expected returns on traditional assets are trending lower than their historical averages, the same is not true for the associated risks. Given this, setting investors’ expectations may be more important today than ever.

Risk and return are central to investing. But while investors generally agree on how to define returns, risk is the subject of much disagreement, and as a result, often the source of forced selling when true risks do materialize. This study introduces a simple, intuitive definition of risk to help investors set expectations for their own portfolios: what’s the worst I should expect to see over my investment horizon?

We show these “worst outcomes” for periods lasting one year up to five years and quantify how diversification can help mitigate them. Starting with traditional asset classes, we find stock/bond diversification tends to add value during these worst outcomes – especially over multi-year periods.  

Good things come to those who wait (0:18)


We also look beyond traditional assets by adding commodities to a stock/bond portfolio. Here again we discovered a consistent improvement to worst outcomes. Of practical importance to investors, we find a little can go a long way – e.g., diversifying even “half-way” can capture much of the benefits. 

You don’t need to be “perfectly” diversified (0:16)


Many investors use alternatives to try to improve their overall portfolio’s risk-adjusted returns. To investigate the role these strategies can play in risk reduction, we calculate the impact of reducing a portfolio’s volatility, while maintaining its average returns. This is arguably a conservative goal for many alternative investors, and we show a meaningful benefit in expected worst outcomes. 

The impact of adding alternatives to a diversified portfolio (0:20)


While alternatives can reduce the length and depth of losses in many portfolios, investors’ exposure to illiquid strategies may present more risk than meets the eye. Although illiquids may report lower volatility than their liquid counterparts, we find their true risk from a worst outcome perspective is larger than investors realize. 

Risk considerations of illiquid assets (0:12)

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The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results.


Hypothetical performance results have many inherent limitations, some of which, but not all, are described herein. The hypothetical performance shown was derived from the retroactive application of a model developed with the benefit of hindsight.  Hypothetical performance results are presented for illustrative purposes only.


Diversification does not eliminate the risk of experiencing investment loss.


Certain publications may have been written prior to the author being an employee of AQR.

This material is intended for informational purposes only and should not be construed as legal or tax advice, nor is it intended to replace the advice of a qualified attorney or tax advisor.


AQR Capital Management is a global investment management firm, which may or may not apply similar investment techniques or methods of analysis as described herein. The views expressed here are those of the authors and not necessarily those of AQR.