Balanced complexity

One of the major pillars of investing is losing strength. The banaced portfolio, where investors allocate 50-60% in equities and 40-50% on bonds to counterbalance risks and smooths returns through diversification, rests on the fact that correlations between stock and bonds are negative enough that the combination lowers volatility for the overall portfolio. The problem? The chart below shows a study from the IMF where the correlation of U.S. stocks and bonds is trending higher after the pandemic, and the same phenomenon is happening with G4 assets. Liquidity and easy money thanks to central banks dovish policies may be the reasons behind it, which indicates that this situation might be cyclical, but the reality is that diversification is getting tougher to implement only with stocks and bonds. Some investors are aware of this, and have tweaked the balanced portfolio by adding alternatives to the mix, or lately, some precious metals such as gold or silver. They are also bringing non G4 assets to the mix, such as Emerging Markets, which do diversify but add volatility, particularly during times of stress. The simplicity of the balanced portfolio, which is perhaps its biggest strength, is being questioned. It’s getting increasingly difficult to diversify.

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