Harmful Diversification: Evidence from Alternative Investments
The British Accounting Review, Forthcoming
50 Pages Posted: 4 Feb 2017 Last revised: 15 Aug 2018
Date Written: August 14, 2018
Alternative assets have become as important as equities and fixed income in the portfolios of major investors, and so their diversification properties are also important. However, adding five alternative assets (real estate, commodities, hedge funds, emerging markets and private equity) to equity and bond portfolios is shown to be harmful for US investors. We use 19 portfolio models, in conjunction with dummy variable regression, to demonstrate this harm over the 1997-2015 period. This finding is robust to different estimation periods, risk aversion levels, and the use of two regimes. Harmful diversification into alternatives is not primarily due to transactions costs or non-normality, but to estimation risk. This is larger for alternative assets, particularly during the credit crisis which accounts for the harmful diversification of real estate, private equity and emerging markets. Diversification into commodities, and to a lesser extent hedge funds, remains harmful even when the credit crisis is excluded.
Keywords: Alternative assets, diversification, estimation errors, transactions costs, non-normality, regimes
JEL Classification: G11
Suggested Citation: Suggested Citation