“We have built some really fast cars, but haven’t spent much time on the safety,” he said. No doubt the financial instruments created recently carried a lot of risk; in many cases more than most people assumed, and investors became overexposed. But being diversified, as in crises before, would have provided little protection. According to State Street’s research, when markets are up by 7 per cent or more, the correlation between assets tends to be about 30 per cent. But when markets are down by 7 per cent or more, the correlation between assets rockets to around 70 per cent.

Because of the asymmetrical
nature of the way assets tend to correlate, diversification ends up providing
as much shelter as Mark Twain’s banker; a fellow who lends you his umbrella
when the sun is shining, but wants it back the minute it begins to rain, Page
said. “We as an industry have failed at risk management, because we have failed
to realise that risk changes over time. Diversification doesn’t help because
what we think is safe today may not be safe tomorrow. An event may be an
outlier of four standard deviations, but it can still happen, and when it does it
will be unexpected; as that is the very nature of an outlier event,” Page said.