Real assets: Diversification benefit & returns are shrinking

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.

Real assets: Diversification benefit & returns are shrinking

Postby Browser » Fri Feb 08, 2013 12:05 pm

An interesting analysis by Ben Inker at GMO suggests that the benefits from allocating to real assets (portfolio diversification and expected returns) have been driven much lower. It might be time to rethink whether real return assets such as commodities and TIPS are going to have the same importance in the future that they have had in the past.
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.

Commodities:
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.

TIPS:
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.

Conclusion:
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

http://www.gmo.com/websitecontent/GMO_QtlyLetter_4Q2012.pdf
If we have data, let’s look at data. If all we have are opinions, let’s go with mine. – Jim Barksdale
Browser
 
Posts: 2614
Joined: 5 Sep 2012

Re: Real assets: Diversification benefit & returns are shrin

Postby rmelvey » Fri Feb 08, 2013 6:57 pm

Great paper, thanks for the link. A lot of the GMO papers are a good read.
User avatar
rmelvey
 
Posts: 403
Joined: 18 Sep 2010

Re: Real assets: Diversification benefit & returns are shrin

Postby dharrythomas » Fri Feb 08, 2013 11:08 pm

Correlations between asset classes like returns are highly variable over time. Correlations tend to increase when people start using the asset class to diversify thier portfolios. Returns also tend to converge in a crisis when everything goes down. Gold is a great diversifier but you have to be willing to take those 20 year stretches of negative returns to reap the benefits (or get the market timing right).

You pay your money, you take your chances.

Good Luck

Harry
dharrythomas
 
Posts: 521
Joined: 19 Jun 2007


Return to Investing - Theory, News & General

Who is online

Users browsing this forum: bodominiums, Boglegrappler, DaufuskieNate, Digital Dave, fabdog, jjcarpenter, juanito55, shorvath, tecmage and 89 guests