Traditional approaches to portfolio diversification don’t always work the way investors might anticipate, according to new insights based on Morningstar Indexes.
In fact, four basic portfolio building blocks ― US larger stocks, US small caps, international stocks, and US bonds ― have provided some diversification benefits over the past few years while being positively correlated with each other, flying in the face of conventional wisdom about diversification through negative asset class correlation.
In his recent article ― Why Portfolio Diversification Is About More Than Just Correlations ― Morningstar Indexes Strategist Dan Lefkovitz provides examples of when asset classes performed in both unexpected and expected ways:
- US fixed income, as represented by the Morningstar US Core Bond Index, performed the ways bonds are expected to perform during rocky times for US equities, offsetting negative equity returns during stock market panics in 2025, 2020, 2008, 2002, and 2000. Yet bonds fell along with stocks in 2022, amid rising inflation and interest rates.
- In the first decade of the millennium, 2000–2009, a difficult one for US stock investors, bonds actually outperformed equities. US small caps and international stocks beat larger US stocks by a wide margin. Unlike our current market environment, investors holding international and small-cap stocks performed better than those who were just invested in the top of the market.
Dan Lefkovitz – Strategist, Morningstar Indexes:
“Investment leadership is changeable and the relationship between asset classes is fluid. Investors diversifying their portfolios should remember that asset correlations of recent years may not persist. Bonds are capable of beating stocks over certain periods, and let’s not count out small caps and international stocks, which have led in certain periods. It’s important for investors to understand that portfolio diversification is about more than looking at recent correlation data.”
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