Substitutes, Complements, and Diversifiers: Three Ways to Reduce Equity Risk

  • Stocks are riskier than bonds, so equities account for a disproportionate amount of portfolio risk in a 60% stock / 40% bond portfolio.
  • Reducing equity risk involves selecting an investment strategy to help offset that risk, either through lower beta to stocks or greater diversification.
  • Equity risk-mitigating strategies come in many forms and with varying levels of complexity.
  • Categorizing these assets as equity substitutes, equity complements, and equity diversifiers can help determine which strategy is most appropriate for a portfolio.
  • Each equity risk-mitigating strategy has a unique risk and return profile, so selecting an appropriate strategy depends on an investor’s portfolio objectives, constraints, and outlook.