Eggs Not Enough: The Truth About Diversification

October 22, 2012

Diversification remains one of the most important considerations as investors design their investment portfolios. Asset classes have distinct volatility, correlation, and risk premium characteristics in both recessionary and expansionary periods. Employing long-term historical relationships across asset classes could lead to substantial underperformance when regime shifts happen because volatilities for various risky asset classes tend to be low in equity bull markets and high in equity bear markets.

Investors should pay attention to how they achieve diversification in their portfolios. In recessionary periods, correlations between asset classes rise. Investors need to ensure they shift their asset allocation as regimes change. Capturing this time-varying characteristic is important for obtaining mean-variance portfolio optimization. When the road is smooth and straight, investors can carry as many baskets of eggs as they want to. But when it is bumpy and twisted, investors need to diversify the goods they are bringing to market—adding carrots, corn, and sweet potatoes, for example, in the event that their vehicle drives off the road.


  1. We use the NBER recession dates to determine whether a period is Expansionary or Recessionary.
  2. This result is not all that surprising given the well-known fact that NBER cycle definition tends to lag behind capital market movements.


©2012 Research Affiliates, LLC. The material contained in this document is for general information purposes only. This material is not intended as an offer or a solicitation for the purchase and/or sale of any security or financial instrument, nor is it advice or a recommendation to enter into any transaction. Nothing contained in this material is intended to constitute legal, tax, securities, financial or investment advice, nor an opinion regarding the appropriateness of any investment. Research Affiliates, LLC, is an investment adviser registered under the Investment Advisers Act of 1940 with the U.S. Securities and Exchange Commission (SEC).

FEIFEI LI, Director, Head of Research, Research Affiliates, LLC.



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