Portfolio Construction
New Rules of Diversification
How to Prep Your Portfolio for a Different Kind of Recession Risk
Q3 2022
Topics - Portfolio Construction Portfolio Risk and Performance Asset Allocation Alternative Investing Macroeconomics
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.
This document 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.
This document has been provided to you solely for information purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and AQR Capital Management, LLC (“AQR”) to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. This document is not to be reproduced or redistributed to any other person. The information set forth herein has been provided to you as secondary information and should not be the primary source for any investment or allocation decision. Past performance is not a guarantee of future performance. Diversification does not eliminate the risk of experiencing investment losses.
This material is not research and should not be treated as research. This paper does not represent valuation judgments with respect to any financial instrument, issuer, security or sector that may be described or referenced herein and does not represent a formal or official view of AQR. The views expressed reflect the current views as of the date hereof and neither the author nor AQR undertakes to advise you of any changes in the views expressed herein.
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. Charts and graphs provided herein are for illustrative purposes only. The information in this presentation has been developed internally and/or obtained from sources believed to be reliable; however, neither AQR nor the author guarantees the accuracy, adequacy or completeness of such information. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially, and should not be relied upon as such. Diversification does not eliminate the risk of experiencing investment losses.
The information in this paper may contain projections or other forward-looking statements regarding future events, targets, forecasts or expectations regarding the strategies described herein, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different from that shown here. The information in this document, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.