Practical Applications of When to Diversify Differently

Abstract

In <ext-link><bold><italic>When to Diversify Differently</italic></bold></ext-link>, from the March 2022 multiasset special issue of <bold><italic>The Journal of Portfolio Management</italic></bold>, authors <bold>Brian Jacobsen</bold> and <bold>Matthias Scheiber</bold>, both of <bold>Allspring Global Investments</bold>, determine that changes in the correlation between returns on stocks and bonds tend to be caused by financial crises and changes in investors’ fears about inflation. For the past few decades, investors have allocated assets to stocks and bonds based on the theory that the two are negatively correlated. However, before 1997, stocks and bonds had a greater propensity to decline simultaneously. Jacobsen and Scheiber find that negative stock–bond correlation is associated with low real interest rates and low inflation, while positive correlation is associated with higher rates and inflation. During a market drawdown, the correlation depends on the cause of the drawdown. If the cause is fear of higher inflation, then the correlation tends to be positive. If the cause is fear of recession or geopolitical issues, and if inflation is low, then the correlation tends to be negative and bond allocations may help protect against equity losses.