As everyone now knows as a result of late-2008's financial crisis, return correlations between most asset classes, originally thought to behave differently one from another, can converge during times of extreme market stress. One fascinating manner of thinking about this problem is discussed in a PIMCO market commentary by Vineer Bhansali.

Bhansali argues that we must progress from thinking about investment diversification in term of asset classes to thinking about risk factors and accounting for them independently of how they're embedded in the range of asset classes available to investors. In other words, although people expect the fixed-income portion of their portfolio to bolster returns as the equity side collapses, this view ignores the fact that many bond sectors themselves hold an equity risk factor.   More 

Why did correlations go to one?

My friend Carl Richards made an interesting observation in his last post:

Just when we need something to zig, they all zagged together!

Some people draw the conclusion that diversification no longer works. I strongly disagree. (Behaviorists would call that representative bias.)   More 

A few months ago, a friend and fellow advisor expressed his frustration that just at the time that we really needed the benefits of noncorrelated asset class investing, correlations went to one.

It was true: There was nowhere to hide during the financial crisis. That is one of the things that made it so painful.   More