Global Investing

The Wrong Lesson

December 3, 2008

 

Investors learned the wrong lesson from the dotcom bubble, and ended up blowing another. 

 

That’s the view put forward at the CFA Institute’s conference in Amsterdam by Ben Inker, head of asset allocation at GMO. He believes investors became so enamoured of diversification – which seemed to work like a charm for the large US university endowment schemes – that they ran headlong into risk asset classes and blew a giant risk bubble. 

 

Inker argues that because investors rushed into risk asset classes indiscriminately, they ended up paying for the privilege of taking risk.

 

“What you cannot do is say: ‘Because I’m diversified, I can take more risk.’ But after the internet bubble, diversification became the mantra,” he said. “Investors looked uncritically at the idea of having a diversified portfolio. That made the risk/return curve negatively sloping.” In effect, investors were paying more to take on risk. 

 

A small crumb of comfort for those diversified investors surveying the remnants of their portfolios, is that markets have fallen so far you are now once again being paid to take on risk. But is there anything they could have done to avoid this unpleasant sequence of events in the first place? 

 

Inker suggested they should have gone short risk. Unfortunately, as he conceded, it is not possible for the whole market to do this. 

 

Lesson learned?

 

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