Analysis: Investors may be stoking the volatility they fear

Wed May 30, 2012 3:26pm EDT
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By Mike Dolan

LONDON (Reuters) - Long-term investors fearful of another global financial storm may be better prepared than they were before Lehman Brothers went bust in 2008, but their increasingly nervous disposition could itself be making markets more fragile.

The Lehman collapse and hyper-correlated decline in risky assets everywhere challenged a key long-standing investment tenet that broad diversification of portfolios was sufficient to protect overall savings over time.

In the dark six-month period after September 2008, there were few if any havens from a synchronized slump in equity, commodities, emerging markets, high-yield debt, hedge funds and the like.

Cash, top-rated government bonds and more esoteric "tail risk" hedges such as volatility indices were the only places to hide.

And for many long-term players, pension funds and insurers with 20- or 30-year horizons, that shock may still amount to just a short-term hiatus that fundamentals will correct over time.

But less than four years later, the still-smoldering banking crisis now threatens a fracturing of the euro zone, with some comparing a possible Greek exit from the single currency to a Lehman-style moment and another systemic market shock.

The question for many funds is whether you close your eyes and hope greater diversification will be enough to see through another meltdown, or whether you deliberately build in plans to head for the bunkers quickly to avoid the worst when it happens.

Both seem to be going on in parallel.   Continued...