Portfolio Construction

New Rules of Diversification

How to Prep Your Portfolio for a Different Kind of Recession Risk

Topics - Portfolio Construction Portfolio Risk and Performance Asset Allocation Alternative Investing Macroeconomics

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New Rules of Diversification

During the first half of 2022, global equity markets tumbled around 20% from their January peak, with losses on typical stock/ bond portfolios almost as large, as bonds offered little refuge. More worryingly, this downturn has a vintage, disco-era look and feel that may be unfamiliar to many younger investors: with inflation still high, there is little prospect of central banks riding to the market’s rescue as they did in 2008 and in 2020.

In this article we assess the prospects for stock and bond markets after the H1 selloff, consider the impact of macroeconomic risks on a range of investments, and explore the use of diversifying investments to fortify portfolios.

Diversification away from traditional assets would have paid off in H1 2022 – finally – after many years of tailwinds for stock/bond portfolios. After a small rebound in July, some equity bulls might suggest it’s time to ‘buy the dip.’ While a further recovery is one possible scenario, our analysis suggests that as of summer 2022, the strategic and tactical case for diversification remained strong. Investors cannot expect to time their reallocations perfectly, and it’s not too late to diversify. We set out the practical considerations for investors (still) minded to batten down the hatches. 

 

About the Portfolio Solutions Group
The Portfolio Solutions Group (PSG) provides thought leadership to the broader investment community and custom analyses to help AQR clients achieve better portfolio outcomes.

We thank Alfie Brixton, Pete Hecht and Thomas Maloney for their work on this paper. We also thank Jonathan Fader, Roberto Giuffrida, Antti Ilmanen and Dan Villalon for helpful comments.

 

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The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons.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.