by Craig Basinger on 12/09/09 at 9:34 pm
Since the dawn of finance, the benefits of diversification have been drilled into the thought process of just about every investor. Combining different asset classes provide a targeted return and reduced risk, as measured by volatility. It is really a simple mathematical exercise that proves adding asset classes to a portfolio that are not perfectly correlated betters the risk return tradeoff. Unfortunately, one event can disrupt this historical relationship and that is a credit crisis, which we are in the middle of. A credit crisis triggers massive deleveraging and increased risk aversion which results in many asset classes abandoning their historical trading patterns and becoming highly correlated. Muting the benefits of diversification exactly when needed the most.
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