Identifying Real Risks in Portfolio Is Crucial to Make Diversification Work in Volatile Markets, According to Mellon Capital Management

BNY Mellon Investment Boutique Advises Tactical Implementation Of Three-Pronged Approach

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Jul 22, 2010, 08:02 ET

SAN FRANCISCO, July 22 /PRNewswire-FirstCall/ -- Most diversification strategies appeared to fail following the collapse of Lehman Brothers in September 2008 because investors did not sufficiently distinguish between risky assets and relatively safe assets such as U.S. Treasury bonds, according to a recent analysis by Mellon Capital Management Corporation, part of BNY Mellon Asset Management.

"Traditional diversification did not provide the typical level of risk reduction during the 2008 financial crisis," said Michael Ho, chief investment officer of Mellon Capital. "One of the most frightening aspects of the 2008 crisis was that all risky assets sank in lockstep resulting in devastating losses. Our challenge is to craft a portfolio to withstand a perfect storm."

The Mellon Capital study concluded that investors would fare better during a period of high volatility and low liquidity such as the financial crisis that began in September 2008 by tactically following a three-pronged program:

Actively reducing market exposure,
Making passive investments in assets that historically have done well in market shocks, and
Implementing strategies that historically have done well during increasing volatility.

The Mellon Capital study noted that picking the right moment to reduce market exposure depends on correctly anticipating whether the economy will be adversely affected by the market downturn, which can be difficult to determine by measuring volatility levels alone. As a result, Mellon Capital is continuously analyzing methods to interpret stress events. Ho said, "Key to implementation of this approach is distinguishing between little shocks and super shocks, which is when it is especially important to identify safe assets."

The paper noted Treasury bonds performed especially well during flights to safety associated with previous spikes in equity volatility, and the 2008 episode conformed to this pattern. Traditional diversifiers such as commodities, real estate investment trusts and stocks have performed well only during periods of less-intensive shocks.

Strategies that tended to perform well during periods of increasing volatility include trend-following strategies, pure market-neutral strategies, statistical arbitrage, and high-frequency trading. These strategies seek to exploit the opportunities created by the market dislocation and the aftereffects of the shock on the economy.

Notes to Editors:

Founded in 1983 by innovators in the investment management field, Mellon Capital Management Corporation applies a disciplined and analytical approach to global investment management strategies. As of June 30, 2010, the firm had $170.6 billion in assets under management, including assets managed by dual officers of Mellon Capital Management Corporation, The Bank of New York Mellon and The Dreyfus Corporation, and $9.1 billion in overlay strategies. Additional information about Mellon Capital is available at www.mcm.com. It is part of BNY Mellon Asset Management, one of the world's largest asset managers.

BNY Mellon Asset Management is the umbrella organization for BNY Mellon's affiliated investment management firms and global distribution companies.

BNY Mellon is a global financial services company focused on helping clients manage and service their financial assets, operating in 36 countries and serving more than 100 markets. BNY Mellon is a leading provider of financial services for institutions, corporations and high-net-worth individuals, providing superior asset management and wealth management, asset servicing, issuer services, clearing services and treasury services through a worldwide client-focused team. It has $21.8 trillion in assets under custody and administration and $1.0 trillion in assets under management, services $11.6 trillion in outstanding debt and processes global payments averaging $1.5 trillion per day. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation (NYSE: BK). Additional information is available at www.bnymellon.com.

All information source BNY Mellon Asset Management at June 30, 2010. This press release is qualified for issuance in the UK and US and is for information purposes only. It does not constitute an offer or solicitation of securities or investment services or an endorsement thereof in any jurisdiction or in any circumstance in which such offer or solicitation is unlawful or not authorised. This press release is issued by BNY Mellon Asset Management (US) and BNY Mellon Asset Management International Limited (ex-US) to members of the financial press and media and the information contained herein should not be construed as investment advice. Past performance is not a guide to future performance. Registered office of BNY Mellon Asset Management International: The Bank of New York Mellon Centre, 160 Queen Victoria Street, London, EC4V 4LA. Registered in England no. 1118580. Authorised and regulated by the Financial Services Authority

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SOURCE BNY Mellon