“Everything is falling—is diversification dead?”

When the value of most major assets falls in unison, it's time for the big critics to come out: diversification, they argue, doesn't work. Ali Masarwah, fund analyst and managing director of the consulting firm envestor, objects to this criticism, which bothers him for a very specific reason.
 

March 9, 2026. FRANKFURT (envestor). There are always arguments as to why diversification supposedly does not work. In 2022, many CAT bond funds took a tumble – just when the interest rate markets suffered their crash of the century. The diversification effect of catastrophe bonds was zero. So have CAT bonds failed? The situation is similar today: frontier stock markets have fallen sharply in the past two weeks. How does this fit in with the argument that frontier stocks are not very integrated into global investment markets and therefore provide good diversification?

There are unfair and fair arguments against the principle of diversification. One entirely understandable argument is that diversification only works to a limited extent in times of acute crisis. When you need it most, it is often not there. This has been the case in many crises, when even (supposedly?) diversified portfolios have suffered heavy losses. This was the case in March 2020, when US government bonds faltered during the Covid crisis, and it has also been observed in the last ten days since the start of the third Gulf War: gold, Bitcoin, bonds, stocks – everything fell.

Let's start with the understandable criticism. Here, it is advisable for investors to detach themselves from day-to-day developments on the stock markets. Short-term movements on the capital market reflect investor sentiment rather than the fundamental nature of an asset. When investors panic, there is often no stopping them. Gold is insurance against extreme events – are we experiencing such an extreme event? – but if investors are now taking profits after a long gold bull market and pushing the gold price down by ten percent, this is not a fundamental argument against the precious metal. Perhaps investors are reducing their portfolio winners in order to increase their losers? That would be textbook rebalancing!

Another feature of financial crises is that liquidity disappears at certain points – if too many sellers meet too few buyers, this can put pressure on asset prices, even if there are no fundamental reasons for this. Diversification works, but it is not always “available.” Investors should therefore not demonize diversification, but rather question whether they had sufficiently considered the liquidity risk of an asset.

Then there are the unfair arguments against diversification. These include the aforementioned criticism of CAT bonds in 2022 and frontier stocks today. In 2022, Hurricane Ian struck just as bond prices around the world were taking a dive in the wake of rising inflation rates. Does this speak against CAT bonds in general? Currently, all eyes are on the third Gulf War, but not on the equally lethal conflict between Pakistan and Afghanistan. Hardly anyone has this on their radar—but that doesn't change the fact that frontier funds invest more or less heavily in South Asia. Does this speak against frontier markets in general?

Idiosyncratic risks remain idiosyncratic risks even when they manifest themselves in the context of other crises. A high correlation between asset price movements is possible even if there is no causality for a convergence of prices. If a lot of ice cream is consumed in the summer and the number of swimming accidents increases at the same time, this does not mean that increased ice cream consumption leads to drowning.

Investors should therefore try to be more relaxed. Not every price setback signals the failure of diversification. It is certainly a good idea to regularly review your own portfolio critically for undiscovered risks. However, investors should not allow themselves to be intimidated by notorious know-it-alls when prices crash. There are observers who always know better in hindsight. In the absence of the proverbial crystal ball, we mere mortals have no choice but to rely on diversification, even if the free lunch may sometimes be meager.