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Kleinwort says diversified investment not as effective in crisis

Date: Friday, March 7, 2008
Author: Natsuko Waki, UK Reuters.com

LONDON (Reuters) - In times of a financial crisis, investing in a wide range of assets from commodities to hedge funds may not bring the usual diversification benefits, wealth manager Kleinwort Benson said on Thursday.

A diversified portfolio invests in alternative assets such as commodities, hedge funds and real estate along with orthodox instruments such as stocks, bonds and cash.

In theory this gives investors a shield from market turbulence in the long term as different assets which are uncorrelated to each other dampen overall volatility of returns.

Kleinwort's study of correlation between different asset classes in the past 18 years shows commodities were most negatively correlated to other instruments, playing a large diversifying role.

However, data during the current credit turmoil -- between August and January -- shows such a relationship almost disappeared, with commodities showing strong links with equities, hedge funds and private equity.

"In a crisis, short-term correlation rises rapidly. If you see prices falling, fear works faster than greed. The market falls faster than it rises," Jeremy Beckwith, Kleinwort's chief investment officer, told a briefing.

"Diversification doesn't necessarily give you the short-term defensive benefits that you would hope to get by looking at the long-term correlations. This may be disappointing, but diversification is a very successful long term strategy."

For example, while UK real estate in the long-term has very limited positive correlation with stocks, it has in fact shown a negative link with equities since August.

Kleinwort Benson, a member of German financial group Allianz (ALVG.DE: Quote, Profile, Research), manages assets of around 4 billion pounds.