It was funny reading this article because I kept thinking, "Oh, this article is building up to an introduction to the HBPP!"
...But then the article ends with a shrug of the shoulders and a fatalistic acceptance of systemic risk following a cursory and unconvincing description of a few complicated sounding hedging strategies which could (read: wouldn't) hedge against significant conflagration.
Ahh, the HBPP: apparently the best kept secret in finance.
An interesting thought experiment – a breakdown of a typical, well-diversified investment strategy in 1912.
Teetering on the cusp of revolution, war and depression, Sokoloff's point is that, even following a modern portfolio management strategy, the manager would stand to lose the vast majority of their assets. People tend to rely on historically stable relationships between bonds and stocks, and when that relationship breaks down – as often happens in a liquidity event – even complicated strategies involving some arbitrage, essentially blow up.
Imagine being a wealth manager out of Geneva in 1912, trying to create a nice diversified portfolio of developed market bonds, and emerging market bonds, says Sokoloff.
Say 39% of client assets would be split between stocks of Great Britain, France, German Empire, Austria-Hungary and Italy: truly mature, developed markets.
Some 21% of assets would go into stocks of the two fastest growing economies: Russian Empire and North American United States. The wealth manager might also put a smidge into emerging economies like Argentina, Brazil or Japan.
In bonds, allocation would be somewhat similar. Gilts with sub-3% yield would be the benchmark, with the rest of developed and emerging bonds trading at a spread.
Alternatives investment could be in anything ranging from arable land in central Russia or the Great Plains, to shares of new automotive or aeroplane startups in Europe and America, to Japanese manufacturing ventures.
This well-intentioned, balanced portfolio would be in for a wild ride in the next decade and possibly drawdowns of as much as 80%. The saving grace would have been to invest in Detroit startups or other investments that successfully straddled wars, Russian revolution, crises and the technological boom of the early 20th century.
Sokoloff told IBTimes UK: "That thought experiment is really frightening to me. You followed very sound modern portfolio management advice back then and still in ten years your portfolio is gone. I don't think we are really learning the lessons of history, especially now that the global economy is so much more interconnected than it was before...."