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Investment Commentary

Asset classes are like siblings…distinct but closely related

By Kent Demien | Johnson Financial Group • August 04, 2022

3 minute read time

During a recent backyard barbecue with family and friends, I looked up from behind the grill at the dozen or so kids and was struck by how similar siblings looked to one another. Within sets of siblings, each child was distinct yet shared unmistakable features. Think of asset classes like siblings. They are clearly distinct. High-yield bonds and large-cap U.S. stocks, for example, are entirely different types of securities. With bonds, investors expect to receive an income stream plus interest (and potentially capital gains). With stocks, the opportunity is capital gains plus any dividends the companies may pay. Yet despite their differences, these asset classes are siblings. The performance characteristics of high-yield bonds and large-cap U.S. stocks are correlated—that is, relate to one another—especially when there is stress in the market.

Covid market stress

The Covid shock at the beginning of 2020 is a good example of how these “sibling” asset classes tend to demonstrate their “relatedness” when under stress. The following chart plots the daily change in yield for the ICE BofA US High Yield Index against the change in return for the S&P 500 from January 1, 2020 to March 20, 2020. Draw a line with your eye through the dots. The line is upward sloping from the left to the right, showing a clear correlation. As the markets sold off quickly, bond yields rose (which lowered the bond prices shown on the graph) and stocks fell.

The line is upward sloping from the left to the right, showing a clear correlation. As the markets sold off quickly, bond yields rose (which lowered the bond prices shown on the graph) and stocks fell.

Implications for portfolio construction

This relatedness is not limited to high yield and equities. Many asset classes share similar risk-return characteristics—to a degree that thinking in terms of “risk factors” is just as important, if not more important, than thinking in terms of “asset classes.” Without attention to overlapping risk characteristics, an investment manager might inadvertently put too many eggs in one type of basket, working against the inherent benefits of diversification—and thereby increasing overall portfolio risk. At Johnson Financial Group, our approach emphasizes portfolio construction based on different “risk families.” We apply sophisticated tools to help us monitor portfolio risk and, critically, to understand how assets will behave in different market stress scenarios. Harry Markowitz, Nobel laureate and father of Modern Portfolio Theory, once said “diversification is the only free lunch in investing.” His point was to increase the diversification of risks inside your portfolio…not just the names of various security types. So, understanding how assets relate to one another is essential to achieving that “free lunch” of an improved risk/return profile via diversification. Have a great rest of your summer. Just don’t forget to take your kids home after the barbeque. I know which ones are yours because they look just like you.

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This information is for educational and illustrative purposes only and should not be used or construed as financial advice, an offer to sell, a solicitation, an offer to buy or a recommendation for any security. Opinions expressed herein are as of the date of this report and do not necessarily represent the views of Johnson Financial Group and/or its affiliates. Johnson Financial Group and/or its affiliates may issue reports or have opinions that are inconsistent with this report. Johnson Financial Group and/or its affiliates do not warrant the accuracy or completeness of information contained herein. Such information is subject to change without notice and is not intended to influence your investment decisions. Johnson Financial Group and/or its affiliates do not provide legal or tax advice to clients. You should review your particular circumstances with your independent legal and tax advisors. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your taxes are prepared. Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment losses. Certain investments, like real estate, equity investments and fixed income securities, carry a certain degree of risk and may not be suitable for all investors. An investor could lose all or a substantial amount of his or her investment. Johnson Financial Group is the parent company of Johnson Bank, Johnson Wealth Inc. and Johnson Insurance Services LLC. NOT FDIC INSURED * NO BANK GUARANTEE * MAY LOSE VALUE