The case for diversification where everything looks correlated
I often see this argument thrown around these days online that diversification doesn't work because everything moves together. Correlations are ~1. Only the VIX moves in opposite direction but that is hard to trade. MPT is stupid! And these arguments kind of make sense. Just look at the recent sell offs. Bonds, Equities, Commodities, Crypto, REITS; all down across the board. That is why we often see people come in and say you won't make money by diversification, you need to go all and do high conviction plays. Then they'll sight some exceptions as the rule. This is of course bad advice since this is a good way to go broke.
Here's the thing: People look at MPT's message wrong. Of course correlations don't hold in real world. Of course expected returns are not real world returns. Forward volatility and returns will be different than what was in the past. Trying to model it based on past data is mostly a waste of time. The good news is you don't need to. We tend to look at the message of MPT and diversification all wrong. Only in hindsight we will know which allocation combination was best. Which asset class was the best performer. In Nov 2021, I have no idea what will happen in 2022 or beyond. This is exactly why you should diversify.
It is not about capturing the best returns. It is about not getting wrecked when the crash comes or when something underperforms. Survival and getting decent returns will be good enough (Unless you are a master trader, in which case you won't be reading my blog). Few can get rich trading. For others, it is about wealth preservation. It doesn't matter if everything goes up and down together. The magnitude will be different. If you are overexposed to Nifty India, a bigger crash in India vs US for some reason will have you struggling to meet your needs. Bonds will crash much less than other assets. You can sell them to meet short term needs. Forget crashes, there will be prolonged periods where other asset classes will fly while others will give merely any returns. None of this is revolutionary. You want to have exposure to other assets for that case. Nothing is invincible. There's a chance crypto crashes too low, there's a chance the S&P 500 underperforms Nifty in returns. Some geopolitical event, some pandemic, something can always occur. Things will move in different magnitude. The point of diversification is to ensure that our wealth is preserved from that risk. Just pick an allocation, there's a lot of free information available online on this and everyone has their own style. But don't go all in unless you know what you are doing.
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