The diversification dilemma – when bonds and equities fall together

The traditional portfolio asset allocation model is broadly one that invests in bonds and equities and the more equity exposure the portfolio has the greater the portfolio's investment risk. Traditionally the price moves of bonds and equities have had a negative correlation, that is when one rises in value the other tends to fall in value. As such they historically have provided a good level of diversification, so during periods of equity market weakness the bond portion of an investment portfolio has tended to rise as investors seek safety in fixed-income investments. Similarly when equity markets rally, bond markets tend to weaken. However, it is a relationship that is not set in stone and varies over time.

During short periods of time, both assets can rise and fall in tandem, i.e. their correlation becomes positive. The start of 2022 has been a perfect example of this. The chart below shows the performance of bond/equity portfolios with varying equity exposures from the start of 2022 up until 21st April.