Comments on: In A Crisis, Correlation Goes To One http://amateurassetallocator.com/2009/07/29/in-a-crisis-correlation-goes-to-one/ Amateur Asset Allocator Fri, 10 Feb 2012 18:16:33 +0000 hourly 1 http://wordpress.org/?v=3.2.1 By: KenC http://amateurassetallocator.com/2009/07/29/in-a-crisis-correlation-goes-to-one/comment-page-1/#comment-4645 KenC Wed, 12 Aug 2009 03:17:47 +0000 http://amateurassetallocator.com/?p=2074#comment-4645 I agree that staying the course during times when the market is in panic is key. However my impression of the endowment situation is that because they are required to produce cash on a regular basis to the University, being over invested especially in less liquid investments puts them in a bad situation when panic strikes. They either have to try and cut spending that is funded by the endowment or sell at a loss to provide the required cash. I think one key to sticking with the course is making sure that in good times or bad you have the cash reserves to do so. This goes for any investor. I agree that staying the course during times when the market is in panic is key. However my impression of the endowment situation is that because they are required to produce cash on a regular basis to the University, being over invested especially in less liquid investments puts them in a bad situation when panic strikes. They either have to try and cut spending that is funded by the endowment or sell at a loss to provide the required cash. I think one key to sticking with the course is making sure that in good times or bad you have the cash reserves to do so. This goes for any investor.

]]> By: Investment Fiduciary http://amateurassetallocator.com/2009/07/29/in-a-crisis-correlation-goes-to-one/comment-page-1/#comment-4487 Investment Fiduciary Thu, 30 Jul 2009 11:07:14 +0000 http://amateurassetallocator.com/?p=2074#comment-4487 I got calls from clients questioning whether diversification still work. Here is what I told them. Normally, asset prices are driven by multiple economic factors: interest rate, inflation, exchange rate, etc. Fear and greed pay an important but not overwhelming role. In crisis however, the only driver is fear. Investors only see two asset classes: riskless assets (Treasury and gold) vs the rest (risky assets). They don't make distinction among risky assets. The market will not be forever driven by fear. At some point, other economic factors will resume their price setting roles. When the time comes, risky assets will no longer move in locked step and the benefit of diversification will manifest itself. I got calls from clients questioning whether diversification still work. Here is what I told them.

Normally, asset prices are driven by multiple economic factors: interest rate, inflation, exchange rate, etc. Fear and greed pay an important but not overwhelming role.

In crisis however, the only driver is fear. Investors only see two asset classes: riskless assets (Treasury and gold) vs the rest (risky assets). They don’t make distinction among risky assets.

The market will not be forever driven by fear. At some point, other economic factors will resume their price setting roles. When the time comes, risky assets will no longer move in locked step and the benefit of diversification will manifest itself.

]]> By: ObliviousInvestor http://amateurassetallocator.com/2009/07/29/in-a-crisis-correlation-goes-to-one/comment-page-1/#comment-4484 ObliviousInvestor Wed, 29 Jul 2009 15:33:21 +0000 http://amateurassetallocator.com/?p=2074#comment-4484 I really enjoyed a Wealth Track interview a couple months back with David Swenson. One thing he mentioned is that in a true crisis, investors only care about one thing: Risk. When people get scared, they pull money out of every asset with a hint of risk, and pour it into the lowest-risk thing they can find. And as a result, real estate prices go down, U.S. stock prices go down, international stock prices go down, and corporate bond prices go down, etc...while everybody flocks to U.S. Treasury securities. It shouldn't be a surprise that correlation moves towards one in such a scenario. To write off the benefits of diversification is to misunderstand what it was intended for in the first place. I really enjoyed a Wealth Track interview a couple months back with David Swenson. One thing he mentioned is that in a true crisis, investors only care about one thing: Risk.

When people get scared, they pull money out of every asset with a hint of risk, and pour it into the lowest-risk thing they can find. And as a result, real estate prices go down, U.S. stock prices go down, international stock prices go down, and corporate bond prices go down, etc…while everybody flocks to U.S. Treasury securities.

It shouldn’t be a surprise that correlation moves towards one in such a scenario. To write off the benefits of diversification is to misunderstand what it was intended for in the first place.

]]>