'Safe' asset gives up 9 yrs gains in 2 weeks?

Why diversification fails us in a crisis

The chart above is shocking.

It's a chart of LQD - the largest ETF tracking investment grade (BBB- or higher) corporate bonds. Investment grade bonds are usually the "safe" portion of an investor's portfolio (most private clients don't own treasuries).

As the chart shows, LQD is trading back at Feb 2011 levels. IT HAS GIVEN UP 9 YEARS' OF GAINS IN TWO WEEKS.

People invest in "buy and hold" ("buy and hope") portfolios that are diversified, with the aim of exploiting the theory that investing in different asset classes with a low correlation to one another will smooth out the returns in a portfolio.

The big problem is that whenever a crisis hits, the different asset classes all start to correlate with each other very closely. When fear strikes the markets, all asset classes tend to fall at the same time. We've seen this movie before!

In other words, diversification works fine when you don't really need it (when markets are relaxed and trending up) but fails you terribly when you need it most (when the sh*t is hitting the fan).

Unfortunately, it's in times like this investors find out what their risk tolerance and investment time horizon really is. And it's one of the reasons I'm a huge advocate of people learning to trade both sides of the markets.

Simon Ree is the author of the forthcoming book "The Tao of Trading". He has 25+ years experience with Goldman Sachs and Citibank.