One of the ‘joys’ of a market crash is that it enables us to test all those asset allocation theories  in real-time. Yay!
A reminder: What we look to do when we construct our passive portfolios is to combine complementary asset classes. This way, when one asset is plunging, other assets will hopefully break our fall.
Diversification stops us placing all our bets on the wrong horse.
What often happens though is that people are not as diversified as they think, or they sack off investing in the more sluggish asset classes during – oh I don’t know – an 11-year bull market. Feeling over-confident, they shun the very asset classes that can stop you losing your mind  when reality strikes.
Well reality has struck and then some. Did diversification work?
If diversification really is ‘the only free lunch in investing’1  then we must have all had a belly full by now.
Let’s see how diversification has delivered even over a relatively short period.
I’ve tracked the impact of the crash on the main asset classes  since global equities hit their 2020 peak on 20 February. All the returns quoted are measured from 20 February using Exchange Traded Funds (ETFs) , and include dividends.
The ETF returns data and charts come from the excellent portfolio-building service JustETF .
From that February high, global equities hit a low of -25.95% on 23 March. (To relive the panic, read this coronavirus crash edit  culled from the Monevator comment threads.)
The markets have rallied since. They were only down -15.45% when everyone knocked off for the weekend on 10 April.
This glib summary understates the drama endured by anyone who stared in horror at this most shocking of bear markets . Many days over the period have seen wild mood swings. The situation has been volatile and movements more violent than normal. It’s been easy to be swept up in the emotion of it all – thanking the heavens for every rally and then wondering where the bottom is as we lurch back down again.
World’s. Worst. Rollercoaster.2 
So far, so horrific for hard-charging investors committed 100% to global equities
But how did things look if you diversified into other equity sub-classes that are commonly held to be a good thing?
Equity diversification in a crisis – looks like this
All correlations ‘go to 1’ in a crisis, and all that. In other words, we all go down the toilet when markets are panicking, and there are no hiding places among equities.
You can see from the line of impact craters (28 February, and 9, 12, 16, and 23 March) that each market fell in lockstep, though the lead changes hands as if they’re a troupe of tumbling acrobats.
Global property and UK equities had the worst of it:
Global Property (the blue line, Amundi’s EPRA ETF)
- Low point: -36.56%, 23 March
- 9 April: -22.5%3 
UK Equities (the red line, iShares’ ISF)
- Low point: -32.33%, 23 March
- 10 April: -20.59%4 
Emerging Markets Equities are renowned for their volatility but haven’t bled as much as they did in 2008 so far… (orange line, iShares EMIM)
I looked at a lot of other markets for respite. It was all just various shades of the brown stuff:
US Equities (IUSA)
- Low point: -26.24%, 23 March
- 10 April: -14.17%
Global Dividends (VHYL)
- Low point: -27.96%, 13 March
- 10 April: -18.04%
Global Multi-factor (FSWD)
- Low point: -27.09%, 13 March
- 10 April: -15.33%
Global Momentum (FSWD)
- Low point: -23.57%, 13 March
- 10 April: -14.01%
Global Quality (IWFM)
- Low point: -24.97%, 23 March
- 10 April: -13.35%
Global Small Cap (WLDS)
- Low point: -34.5%, 18 March
- 10 April: -22.14%
The two brighter spots were:
US Tech: Nasdaq 100 (ANXG)
- Low point: -23.5%, 16 March
- 9 April: -11.68%
Global Low Volatility (XDEB)
- Low point: -21.12%, 13 March
- 10 April: -10.07%
As of 9/10 April, those last two markets show losses that are a quarter to a third less gruesome than global equities.
What does all this reveal? Mostly that equity diversification doesn’t stop your portfolio getting smashed in a bear market.
But it can still help. Your losses would be one-third higher right now if you were 100% in UK equities versus global equities.
But the real diversification benefit comes from other asset classes.
Long government bonds to the rescue
This is why  we hold government bonds. As the stock market routs, high-quality bonds rally.
The chart above shows the famed flight to quality in action. As the mother of all recessions potentially looms, investors protect their capital by buying the bonds of countries that should be able to weather any storm, short of all-out disaster.
High-quality bond prices rise and cushion our portfolios from some of the damage born by equities, if we’re correctly positioned ahead of time.
Long-term, high-quality government bonds perform best in a panic. In the chart above you can see how a long-term, UK gilts  ETF (GLTL) performed against our global equities ETF (VWRL).
In the first couple of weeks of the crisis, long gilts behaved impeccably. They peaked at 11.9% on 9 March, counterbalancing the slide of equities, even as the Saudis and Russians declared an oil price war. VWRL hit -18.46% on 9 March.
The negative correlation of bonds and equities does not work perfectly. Sometimes it does not work  at all.
Equities and long gilts fell together like Holmes and Moriarty from 10 March. Equities slid to -25% on 16 March 16, and long bonds bottomed out at -5.32% on 18 March.
At least your bonds weren’t bombing like equities. But that would have been a hard week anyway you cut it, if you couldn’t pull your eyes off your portfolio.
Why was this happening? Does it matter?
Well, we humans like an explanation. A number of commentators described this phase of the crash as a liquidity crunch: financial titans selling off government bonds and even gold as they tried to cover their losses in equities.
Your best defence as a passive investor  – dwelling far below Mount Olympus – is not to watch the war in the heavens. Ignore the daily drama and give your strategy time to work. A burnt offering or two wouldn’t hurt, either.
Long gilts rallied after 18 March to reach 8.52% on 10 April.
You can see that gilts and equities look broadly correlated with each other after the equity market bottom on 23 March. But the equities rally has only taken shares back to -15.45%.
Bonds in a crisis: short-, intermediate-, and long-term varieties
This chart illustrates the difference between short, intermediate and long-term government bond funds when faced with a recession.
As long as inflation isn’t your enemy, then long bonds tend to benefit most from the flight to quality. Their higher interest rates are a haven for investors as equities and interest rates swan dive.
You can see that the long gilt ETF (orange line) has offered the greatest crash protection overall, though it also fell hardest during the sell-off from 10-18 March. Long bond funds are considerably more volatile than their intermediate and short-term cousins. That’s written into the peaks and troughs of this chart.
The intermediate gilt ETF (blue line) has underperformed the long gilt ETF by over 40% as of 9/10 April, while the short-term gilt ETF (red line) barely registers life. It’s more like cash than anything else. That inertia is fine as far as it goes – short-term bonds will preserve most of your capital over brief timescales – but you don’t get a portfolio boost when you need it most.
The performance of the intermediate- and long-term funds shows why cash is not a good substitute  for bonds in a crisis, defying the claims of many commentators who couldn’t see the point of bonds because interest rates just had to return to normal after the Global Financial Crisis. Ignore-the-crystal-ball-gazers, Lesson #497.
As with equities, I checked out some popular alternatives  to conventional gilts for UK investors:
Global Government Bonds £ hedged (IGLH)
- High point: 4.32%, 9 March
- Low point: -1.13%, 18 March
- 9 April: 1.88%
Global Total Bond Market £ hedged (AGBP)
- High point: 2.3%, 9 March
- Low point: -3.45%, 19 March
- 9 April: -0.38%
The global government ETF is an alternative to the intermediate gilt ETF but has a shorter duration . That shows up in its relative underperformance in this crisis.
The total bond market ETF has a shorter duration still – half that of the intermediate gilt ETF – and it is also hampered in a crisis by some of its lower quality holdings.
The bottom line is that when the world is at panic-stations, a high-quality government bond fund will likely outperform its equivalent total bond market fund due to the flight to quality.
What about inflation-linked gilts and corporate bonds?
Neither sub-asset class should be expected to cover themselves in glory during a crash, and nor have they.
The inflation-linked ETF did awfully during the liquidity crunch that bottomed out 18-19 March, bringing home an equity-like -14.35% loss. Linkers are there to protect us from rampant inflation (think the stagflationary 1970s) but they’ve generally underperformed conventional gilts in deflationary recessions.
Inflation was definitely higher up most investors’ list of concerns than pandemics before now, so don’t go binning off those linkers!
That massive dump of fresh government debt that’s coming will have to be gotten rid of somehow. Inflated away, perhaps?
Just add gold
No disaster management post would be complete without examining the performance of gold .
The chart shows gold’s contribution to the imbroglio in comparison to global equities and long gilts.
Gold is a real loner of an asset class. You’d normally expect gold to plot its own path, indifferent to the concerns of equities and bonds.
Gold does tend to hold up when the bear is on the loose – doing so around four-fifths of the time according to Larry Swedroe’s review of the gold-as-safe-haven  evidence. But it’s erratic. Gold was down 30% at its worst during the financial crisis, for example, before ending up 90% between November 2007 and February 2009.
Gold is doing its job right now. It’s in positive territory – not quite up there with long gilts but better than intermediates – and it bobs about to its own rhythms, acting neither quite like equities nor bonds.
I had a quick look at gold miners and broad commodities while I was as at it. They are regularly cited as plausible diversifiers in the passive investing literature.
Gold Miners (GDGB)
- High point: 4.46%, 24 February
- Low point: -27.22%, 13 March
- 19 April: -2.7%
Broad commodities (BCOM)
- Low point: -17.63%, 1 April
- 9 April: -13.32%
While gold miners and commodities may provide long-term diversification benefits, I don’t recall anybody claiming they would help in a panic. Sure enough, they haven’t.
Diversification vs 100% equities
This diversified portfolio is:
- 60% global equities (VWRL)
- 35% intermediate gilts (GILS)
- 5% gold (SGLN)
In other words, the kind of portfolio that many passive investors may well have picked. (I didn’t go for long bonds because only the very brave would have invested so heavily in them over the last ten years, though with hindsight you would have been handsomely rewarded  for doing so.)
You can see for yourself which portfolio would have helped you sleep better at night. The diversified portfolio is still dominated by equities, so it’s still down. But most of us would be relieved to see losses of only 7% at this stage.
You can also see how a riskier Monevator passive portfolio with a different approach to diversification has fared during the crash .
Spoiler: it’s fine for now. I hope you are, too.
Take it steady,
- First called such in 1952 by Harry Markowitz, the father of modern portfolio theory. [↩ ]
- Note, the flat-top rest points on the chart represent the weekends. [↩ ]
- Last day JustETF are displaying data for, as I write this. [↩ ]
- Last day JustETF are displaying data for, as I write this. [↩ ]