One of the main investment pillars is diversification. It formally started with the Capital Asset Pricing Model and Model Portfolio theory, where, a mathematical model was applied supported by the assumptions of a rational investor and efficient markets. In its simplest form, in order for an investor to diversify, she will need to find 2 or more assets with low or negative correlation, in a way that both have a positive expected return, but their risks (understood as volatilities) are eliminated by combining them in a specific way. Perhaps the most basic applied form of diversification is the balanced portfolio, where stocks and bonds are combined to obtain a long term good risk adjusted returns. As you can see in the chart below, the correlation between stocks and bonds has gravitated around zero over the last 47 years, but is now at an historical maximum when measured in a three year window. That means that your balanced portfolio is losing its diversification benefits, and you either do very well or very poorly, as the balanced portfolio is currently un-balanced. The good news, is that the stock-bond correlation experiences reversal to the mean, and it may start going down towards zero to regain the benefit. In the meantime, it might be advisable to add some uncorrelated or low correlated assets (liquid Alts, commodities, etc) to manage risk.
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