Monday, 22 August 2011

Diversification by Sector & Correlations

Interesting post on diversification by sector:

Looks like diversification among different sectors play a much smaller role in risk diversification during times of turmoil than I thought.

For example: Oil went from being correlated by ~0.5 to ~0.8 in the recent market crash. Telecoms went from 0.65 to 0.85, etc. The only asset class that successfully showed diversification was Gold, Dollar, and Long Bond.

So from a risk diversification standpoint, there's 2 ways to view it, intra-economy (companies producing goods and services) and non-economy factors (gold, commodities, dollar, bonds). Doing diversification solely by focusing on intra economy asset allocation (i.e. tech stocks vs financials) have a limit when a market crisis occurs.

Potential good longer term strategy is during times of high uncertainty, focus on non-economy diversification, and rely on intra-economy diversification during more normal constant growth times.