Asset allocation is considered imperative in creating a diversified portfolio that survives bear markets. As you likely know the current equity bear market took down all asset classes with it including real estate and commodities which are often negatively correlated with stocks. Everyone has been wondering if assets with negative correlation still exist due to the global economy. I ran across an excellent explanation written by a favorite author Larry Swedroe at moolanomy.com. He supports the theory that holding good quality bonds in a portfolio reduces risk.
The article states:
“In times of crisis the only effective diversifier of equity risk is very high quality fixed income investments the safest of which are obligations that carry the full faith and credit of the U.S. government. During this crisis while all equity asset classes were experiencing severe bear markets U.S. Treasury instruments were providing positive returns.”
This theory is further supported in two of my favorite portfolio management books The Gone Fishin’ Portfolio by Alexander Green and the more in depth Investing with Exchange Traded Funds Made Easy by Marvin Appel. While it can be difficult to purchase Treasury bonds in the midst of an equity bull market Green and Appel both provide long term data documenting the portfolio protection doing so provides. It is important to be aware that bond values decrease as interest rates rise and there has been a flight to U.S. Treasury bonds recently thereby driving up prices and pushing yields to extremely low levels.