The GFC and Portfolio Theory

During the global financial crisis (GFC) some commentators (Markowitz et al, 2009) have stated that portfolio theory failed during the GFC due to the following reasons:

  • As asset classes go down, correlations go up
  • This created systemic collapse in all investment sectors

This has lead to new theories such as managed futures being recommended to reduce the risk and increasing the return of a portfolio (Varengold Wertpapierhandelsbank AG, 2009).

However this was not entirely true for all assets. Bonds increased during the GFC as interest rates reduced. Some examples are in the bond market since 2000.

As can be seen in the preceding chart that prior to the GFC bond differentials were in decline during 2006/7, but then increased once the GFC started. Once interest rates started to increase in 2008/9 then we see that bond yield differentials started to stabilise.

This has been then seen in the yields to bond investors, increasing well during this period as seen in the next chart in the side panel.

But the commentators are not entirely wrong. If people held just bonds then their returns prior to the GFC would have been poor. Markowitz et al (2010) recommends that depending on risk capacity, a more cautious portfolio needs to be selected, loaded with lower beta securities or asset classes; or conversely choose a point higher on the efficiency frontier, with higher yield but with higher beta securities or asset classes.

Therefore if the market goes up or down dramatically, those with high beta portfolios will experience reduced correlations and therefore fewer losses.


Bond Yield Charts, FXStreet , 2010, viewed 22 August

Market Portfolio, Investor Words , 2010, viewed 20 August

Markowitz, H. M., Hebner, M. T., Brunson, M. E., 2010,‘Does portfolio Theory work during financial crisis?’, IFA , viewed 21 August

Ross, SA, Westerfield, RW & Jaffe, J, 2010, Corporate Finance, 9th Edition, McGraw-Hill Irwin, New York, USA

Varengold Wertpapierhandelsbank AG, 2009. “Press release”, viewed 21 August 2010

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sensiva 5 years ago

Thank you for an informative article

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