Diversification’s Role as a Risk-Reduction Tool

by Charles Rotblut, CFA and Richard Bernstein

Diversification’s Role As A Risk Reduction Tool Splash image

Richard Bernstein is the chief executive officer of Richard Bernstein Advisors LLC. We spoke recently about diversification and asset allocation.

—Charles Rotblut

Charles Rotblut (CR): You sub-advise a mutual fund that can vary widely in terms of its allocation to bonds and stocks. How do you determine what the right asset allocation is?

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Charles Rotblut, CFA is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at
Richard Bernstein is the chief executive officer of Richard Bernstein Advisors LLC.


Donald Marburger from Texas posted 7 months ago:

The chart showing correlations is quite revealing. I would like to have seen more thoughts and insight into why there has been such a shift.

I personally believe we have been living in an artificial market ever since QE started and will continue to do so until there is no more QE.

Marvin Menzin from Massachusetts posted 7 months ago:

I dont think 5 year covers a full market cycle-- eg in july 13 it leaves out the huge fall in last half of 08
i prefer a full cycle- peak to peak-- so oct 2007 to oct 2013 if its still do high is a good measuring time.
also chart did not include US
stocks -- small mid, large, etc - article too long and rambling--nature of interviews I guess - thx

Fernando Robles from Florida posted 7 months ago:

Spot on investment advice, grounded in financial theory. Excellent!

James Jennings from Virginia posted 7 months ago:

What the Lord don't taketh away, he don't giveth either.

Steve Daniels from Connecticut posted 7 months ago:

I read the interview with Richard Bernstein on Diversification's Role as a Risk-Reduction Tool and thought it was quite good for the most part. However, I felt the article fell short on two issues:

--it failed to point out the fact that correlations across asset classes tend to increase in declining markets which makes diversification harder to accomplish.

--it also tended to ignore correlations of the S&P 500 with alternative investment vehicles (e.g. managed futures, long/short strategies,real estate) which in many cases show lower correlations and, therefore, provide greater diversification benefits.

Sam Wilson from Texas posted 6 months ago:

It certainly is difficult to know the answers to all of these questions. Many of us have our own criteria for finding value stocks. To balance that out on the see saw, one can simply go with the three month CD.

Mark Marotta from New Jersey posted 6 months ago:

Great article. Rich Bernstein, again, does a terrific job. Thanks Rich and thanks AAII.


Thomas Scheller from Illinois posted 6 months ago:

This articles is really good in many respects, emphasizing that diversification is not about about quantity but quality of correlations, and total return being key, not yield.
There is one disturbing misconception:
That negative correlation equals well diversified. It is easy to set up 2 assets that are perfectly negatively correlated with each other - buy the S&P500 and simultaneously short the S&P500. They have (almost) exact negative correlations, and the net effect will be that you have zero volatility and ZERO return.
The goal should be to find assets that have low (ideally zero) correlation, not negative correlation. (They also need to individually have positive return, otherwise keeping cash is better.)
Taking figure 1 alone (and without important info like returns), it would be better to pair gold (correlation=0.3) or long-term treasuries (correlation=-0.4) with the S&P500 than 3-month T-bills (correlation=-0.7).

Mercere Collins from Tennessee posted 6 months ago:

What am I missing here? Seems like the positive correlation items went up because the Fed lowered rates, and vice-versa.

If we just knew in advance what the Fed was going to do we could all have perfect correlations with growth as well.

As he said, back testing can produce whatever the back tester wants.

L Baer from Maryland posted 5 months ago:

Very logical and interesting. Please give us a more comprehensive AAII article on this use of negative correlation to balance my portfolio.

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