Education

Asset Class Diversification Is Not the Same as Risk Factor Diversification

Learn why identifying underlying risk factors can be critical even in highly diversified portfolios.

Even highly diversified portfolios may not adequately cushion market volatility. Understanding the underlying risk factors that many asset classes share can help investors create a more efficient, risk-managed portfolio.

What these charts show

Portfolios may contain unintentional risk. The portfolio shown here is broadly diversified across asset classes, but in fact has a very concentrated exposure to underlying equity risk. It is important to note that diversification cannot ensure a profit or protect against loss in a declining market. It is a strategy used to help mitigate risk.

What it means for investors

Portfolio solutions need to take an allocation approach that looks beyond asset class labels and focuses instead on risk factors – the underlying risk exposures that ultimately drive investment returns.

Asset Allocation (by market value weight)

The pie chart shows an asset allocation portfolio composed of a custom blend of market indexes. Global Equities have the highest allocation at 50%, followed by Fixed Income at 20%, Private Equity at 8%, Hedge Funds at 7%, Real Estate at 7%, Treasury Inflation Protected Securities (TIPS) at 3%, Global Bonds at 2%, Cash at 2%, and Commodities at 1%.

The asset allocation portfolio is a custom blend of indexes. Refer to the end of this material for additional detail. Figures are not indicative of the past or future performance of any PIMCO product.

Risk Allocation (by contribution to estimated volatility)

The pie chart shows a hypothetical portfolio’s risk allocation based on a risk factor’s contribution to estimated volatility. Global Equity has the largest risk allocation at 81%. Other risk allocations include Currency at 6%, Credit Spreads at 5%, Other Factors at 4%, Interest Rates at 3%, and Commodities at 1%.

As of 30 June, 2024. Source: PIMCO. For illustrative purposes only.

¹ See disclosures for additional information regarding volatility estimates.

² Other Factors include non-traditional and idiosyncratic factors.

What this chart shows

Different asset classes often share the same underlying risk factors, which explains the majority of their returns. The chart shows the degree of various risk factor exposure across asset classes. For example, broad equity risk factors are present in a wide range of investments.

What it means for investors

A truly diversified strategy should look beyond asset class labels – first identifying risks that deliver the desired return potential, and then selecting a mix of asset classes that provide efficient exposure to those risks. This allows investors to avoid risk factors believed to be overvalued or carrying excessive downside potential.