as more and more investors scour the world searching for diversifying assets, they will tend to diminish the potential of those assets to help their portfolios. As a result, it may be that we need to rethink the kind of diversification we are likely to be able to achieve.
we’ve taken an asset (long commodity futures) that had a long history of providing a decent risk premium over cash with low correlations to other investments and both increased its correlations with other asset classes and driven its long-term expected return down to the point where it may well be zero or negative.
But if you will humor me for a moment and accept my premise on TIPS, they will have gone from an asset with a fairly high risk premium, driven by the fact that they were not a natural asset to own for any group of investors, to one with a significantly lower risk premium as they are in demand for their hedging characteristics, despite the fact that the basic characteristics of their cash flows have not changed.
TIPS and commodities have been lovely diversifiers historically, and this has led them to be included in more and more portfolios over time. Their effectiveness as diversifiers may well be less in the future and their returns quite likely to be lower. If you are assuming otherwise, what you are really saying is that the market has been inefficient historically and will continue to be inefficient in the same way going forward