Harmful diversification: Evidence from alternative investments

Abstract

Alternative assets have become as important as equities and fixed income in the portfolios of major investors, and so their diversification properties are also important. However, adding five alternative assets (real estate, commodities, hedge funds, emerging markets and private equity) to equity and bond portfolios is shown to be harmful for US investors. We use 19 portfolio models, in conjunction with dummy variable regression, to demonstrate this harm over the 1997-2015 period. This finding is robust to different estimation periods, risk aversion levels, and the use of two regimes. Harmful diversification into alternatives is not primarily due to transactions costs or non-normality, but to estimation risk. This is larger for alternative assets, particularly during the credit crisis which accounts for the harmful diversification of real estate, private equity and emerging markets. Diversification into commodities, and to a lesser extent hedge funds, remains harmful even when the credit crisis is excluded.

Dependence dynamics of Islamic and conventional equity sectors: What do we learn from the decoupling hypothesis and COVID-19 pandemic?

“… Al-Khazali et al, 2014 , Arshian et al, 2020 , Ashraf et al, 2020 , Balcilar et al, 2015 , Diebold and Yılmaz, 2014 , Goodell and Goutte, 2020 , Hernandez et al, 2019 , Lin and Su, 2021 , Marfatia et al, 2020 , Dwita Mariana et al, 2021 , Mroua et al, 2020 , Muteba Mwamba et al, 2017 , Platanakis et al, 2019 , Rehman and Vo, 2020 , Salisu and Sikiru, 2020 , Umar and Gubareva, 2020 .…”

Asset Classes and Portfolio Diversification: Evidence from a Stochastic Spanning Approach

“…Whereas they show that in-sample, non-MV investors can profit from adding commodities to their portfolios, the finding does not hold for the out-of-sample analysis. Yan and Garcia (2017) and Platanakis, Sakkas, and Sutcliffe (2019) do not find that commodities improve Sharpe ratios in-or out-of-sample. Their findings are in contrast to Daskalaki et al (2017)'s, which show that commodities can add value to investors' portfolios.…”

“…An alternative explanation is presented in (Huang and Zhong, 2013) where the authors show that REITs and commodities are not spanned by stocks and bonds before the financial crisis. It is worth noting that the aforementioned studies are challenged by Platanakis et al (2019)'s study, which finds no potential benefit from adding commodities and real estate into stock-bond portfolios.…”

Hedging uncertainty with cryptocurrencies: Is bitcoin your best bet?

“…A well‐established fact is that while diversification can reduce idiosyncratic risk, it may not be able to protect one's portfolio from the various sources of economic risk. This is especially true during crises periods, when correlations between traditional asset classes increase (e.g., Boyson et al, 2010; Brunnermeier & Pedersen 2009; Gromb & Vayanos 2002; Platanakis et al, 2019; Shleifer & Vishny 1997). These observations also serve to highlight the dynamic nature in correlations between investable assets.…”