The single most painful thing that can happen to most investors is an equity drawdown. Finding investments that can do well when equities don’t perform is “the holy grail” for most investors.
Unfortunately, when you look at what happens when equities perform poorly, there isn’t one simple answer that will always win. But allocating to each of the key investments that have provided effective diversification in different equity downturns can create a mix that, as a whole, can achieve the holy grail: helping your portfolio when equities disappoint.
Since 1970, there have been 10 instances when world equities fell more than 15%. It could be divided into two archetypes:
1. “Growth Risks”: The 2000s-era drawdowns—tech bubble burst, financial crisis, Eurozone crisis, and COVID—were each driven by risks to growth that hurt equity markets. Bonds were a very effective diversifier, because low inflation allowed the Fed to ease.
2. “Inflation Risks”: The ’70s/’80s/’90s drawdowns, as well as 2022, were driven by rising inflation that led to Fed tightening. As a result, bonds performed poorly. A basket of commodities was an effective diversifier, capturing the inflationary pressure.
While no one asset reliably performed when stocks fell, a mix of assets can provide more consistent diversification. Holding a mix of bonds and commodities is likely to provide diversification across the range of equity downturns, without paying a premium for that protection.
Source: Bridgewater