Now, post-financial crisis, the search for true diversification is on in earnest. Super funds got the message that correlations move up and down with time, spiking to one in a crisis, just when diversification is really needed. Ryan-Kane, Watson Wyatt’s Hong Kong-based head of portfolio advisory for Asia Pacific, who was in charge of fixed interest at the former County Investment Management at the time of writing the paper, says portfolios will get more “specific” in the strategies they employ. “The Living Room Effect still worries me a bit,” he says. “The theory that the developing world will consume the rest of the world out of trouble seems over-optimistic.”
By “specific” Ryan-Kane means that fiduciary investors will move to fewer strategies which will genuinely behave differently to each other in different scenarios. But the linkages between strategies, as we now well know, make it increasingly difficult to find genuinely uncorrelated investments. One of the ultimate conclusions is that investors should own less equities – both public and private. They will have to look for other return drivers, rather than dividends, which are the last call on profits. “The more things you own, the more likely they will correlate to one in bad times,” he says.
“There has not been enough thought given to the possibility that the things that have been diversified into are not as diversifying as they historically were.” Until the 1990s the world had very different financial systems in the US and Western Europe and the former USSR and China. Then all the privatisations which took place in Russia looked very much like classic Wall Street M&A behaviour. And China completely reinvented itself along the same sort of Western model. There are more than 60 countries involved in the manufacture of the iPod, driven by very small differences in relative competitive advantage, Ryan-Kane says. Another driver of more specific strategies will be the desire for simplicity and clarity. Some investors in Asia could not explain to their stakeholders why they had invested in some of the things they did, such as CDOs which went to zero.