AQR Capital Management examines how stock and bond diversification can break down when inflation shocks drive both assets lower at the same time. The paper challenges the assumption that bonds reliably hedge equities, showing that rising inflation uncertainty can flip correlations and weaken portfolios, especially in environments that resemble pre-2000 regimes.
When Stock-Bond Diversification Fails
AQR
Ashwin Thapar
Research
17 Pages
Key Takeaways
Correlation Regime Shift: Stock-bond correlation has flipped historically, with models explaining about 70% of long-term variation driven by growth and inflation dynamics.
Diversification Breakdown Risk: Moving from -0.5 to +0.5 correlation can increase 60/40 portfolio volatility by roughly 20%, raising drawdown risk meaningfully.
Simultaneous Loss Periods: In H1 2022, equities fell -20.5% and bonds -9.1%, resulting in a -16.0% loss for a traditional 60/40 allocation.
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