The case for diversification is well established in investment theory. By combining assets, whose returns are not perfectly correlated, investors can reduce portfolio volatility without proportionally reducing expected returns. In practice, however, achieving genuine diversification is considerably harder than the theory suggests. Asset classes that appear uncorrelated during normal market conditions frequently move together during periods of stress, precisely when diversification is most needed. This phenomenon – sometimes described as correlation convergence – has been observed repeatedly across different market crises and represents one of the central challenges in modern portfolio construction. Toby Watson has engaged with this challenge throughout his career and brings a practical, analytically grounded perspective to solving it.
The Limits of Conventional Diversification
The standard approach to diversification – combining equities and bonds in varying proportions – has served investors reasonably well over long periods. The negative correlation between equity and bond returns that characterised much of the post-1990 era provided genuine ballast during equity drawdowns, as falling stock prices were often accompanied by rising bond prices, driven by central bank easing.
That relationship has become less reliable. The inflationary environment of 2022 saw both equities and bonds fall sharply simultaneously, delivering losses to investors who had built their diversification framework around the assumption that the two asset classes would continue to move in opposite directions. Toby Watson has pointed to this episode as a reminder that diversification frameworks built on historical correlations need to be stress-tested against a wider range of scenarios, including those that fall outside recent experience.
What Does True Diversification Actually Look Like?
True diversification means holding assets whose return drivers are genuinely distinct – not just assets that have historically had low correlations, but assets whose underlying economics respond differently to the range of macro environments an investor might face. Toby Watson, who spent nearly two decades at Goldman Sachs working across fixed income, structured credit and principal investing, has long argued that factor-based thinking provides a more robust foundation for diversification than asset class labels alone. Two instruments from different asset classes may share the same underlying factor exposures, while two instruments within the same asset class may behave very differently under stress. Understanding these distinctions is what separates genuine diversification from the appearance of it.
How Toby Watson Builds Diversification in Practice
At Rampart Capital, where Toby Watson serves as partner, portfolio construction begins with a clear identification of the risk factors a portfolio is carrying rather than the asset classes it contains. This means mapping exposures to duration, credit, inflation, liquidity and growth – and ensuring that the portfolio is not inadvertently concentrated in any single factor, even if that concentration is spread across multiple asset class labels.
Building genuine diversification often requires going beyond public markets. Private equity, infrastructure, private credit and real assets all offer return drivers that are structurally different from those available in listed markets – not because they are inherently superior, but because their cash flow profiles, valuation dynamics and sensitivity to macro factors differ in ways that can provide genuine portfolio benefits. Toby Watson’s years at Goldman Sachs, spanning structured products, hard asset lending and infrastructure finance across multiple market cycles, give him a detailed understanding of how these asset classes behave under different conditions.
One of the genuine diversification benefits available in private markets is the illiquidity premium – the additional return that compensates investors for accepting assets that cannot be easily sold. For investors with genuinely longtime horizons, this premium is real and has historically been meaningful. Toby Watson has noted that the illiquidity premium is only a benefit if the investor’s liquidity position is managed carefully enough that they are never forced to sell illiquid assets at inopportune moments. Liquidity management is therefore an integral part of diversification, not a separate consideration.
Asset Classes That Contribute Genuine Diversification
Not all alternatives contribute equally to portfolio diversification. A few categories stand out for their ability to provide genuinely distinct return profiles:
- Infrastructure assets – particularly those with long-term contracted cash flows and inflation linkage – offer income stability, real asset backing and low correlation to public equity markets that is difficult to replicate through listed instruments. Energy transition infrastructure adds a further dimension, combining these characteristics with exposure to a structural growth theme.
- Absolute return strategies – when genuinely unconstrained and macro-driven – can provide positive returns across a range of market environments by actively managing factor exposures rather than passively holding them. The key word is genuinely: many funds that carry the absolute return label are in practice more directional than their marketing suggests.
Toby Watson has consistently emphasised that the contribution of any asset class to portfolio diversification must be evaluated in the context of what is already in the portfolio, not in isolation. An infrastructure allocation adds genuine diversification to a portfolio dominated by listed equities, but adds far less to one already carrying substantial real asset exposure.
Correlation Monitoring as an Ongoing Discipline
Diversification is not a one-time construction exercise – it requires ongoing monitoring as market conditions and asset class correlations evolve. Toby Watson has noted that correlation structures shift over time, sometimes gradually and sometimes abruptly, and that portfolios which were genuinely diversified at construction can drift towards concentration without any active decision having been made. Regular reassessment of factor exposures is therefore a core part of responsible portfolio management.
Toby Watson on Diversification as a Long-Term Commitment
Building true diversification across asset classes requires analytical rigour in construction, disciplined monitoring over time, and the willingness to hold assets that may underperform during strong equity bull markets precisely because they are not correlated with equities.
Toby Watson’s career – from structured finance at Goldman Sachs through to his current work at Rampart Capital – reflects a consistent commitment to this kind of long-term thinking. In a world where market conditions shift rapidly and historical correlations cannot be relied upon, genuine diversification remains one of the most valuable things a well-constructed portfolio can offer.
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