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The Myth of Diversification: Risk Factors vs. Asset Classes
Posted: Thu May 10, 2012 3:46 am
by MachineGhost
- In our New Normal world, regime shifts in economic conditions will continue to cause significant challenges for risk management and portfolio construction.
- On average, correlations across risk factors are lower than correlations across asset classes, and risk factor correlations tend to be more robust to regime shifts.
- Risk factors provide a flexible language with which investors may express their forward-looking economic views, adapt to regime shifts and diversify their portfolios accordingly.
http://www.pimco.com/EN/Insights/Pages/ ... asses.aspx
Re: The Myth of Diversification: Risk Factors vs. Asset Classes
Posted: Thu May 10, 2012 12:25 pm
by craigr
I came to the similar conclusion many years ago and wrote about it in 2009:
https://web.archive.org/web/20160324133 ... -approach/
Investors and advisors that focus on these minor asset class risk factors to design a diversified portfolio are making a huge tactical error in my opinion. This kind of thinking is what got them side swiped so hard in 2008 for instance.
Re: The Myth of Diversification: Risk Factors vs. Asset Classes
Posted: Thu May 10, 2012 11:46 pm
by Ad Orientem
Dense reading but interesting. Thanks for posting.
Re: The Myth of Diversification: Risk Factors vs. Asset Classes
Posted: Fri May 11, 2012 6:18 am
by gizmo_rat
Way too dense for my (limited) understanding.
If I even partly understood their argument then a simple single risk factor might be rising interest rates,
However I seem to recall from last year no one is even sure what the effect of this single risk factor would be on a simple portfolio like the PP.
I think they are suggesting that you should consider multiple complex risk factors against what your prediction of market state will be in the future and use this to derive your asset allocations ?
If they had provided example AAs mapped to risk factors mapped to a specific time period in the market, the I might have had more of chance of understanding it.
Unfortunately, the more specific implications of how you might use this methodology to evaluate the PP allocation in volatile markets completely escapes me.
I think it would be easier to learn to read tea leaves.