Equities vs credits: diversification is only “dead” if you view risk through the equity lens
Key takeaway
Most people diversify without even thinking about it. We do not keep all our money in one account, rely on a single skill to earn a living or get our news from just one source. It is a common-sense way of protecting ourselves against things not going according to plan.
That same instinct underpins sound investing. Diversification is not a concession to lower returns, but a practical tool for making outcomes more reliable. Returns are visible day to day, while risk stays hidden until markets come under stress. This can make concentrated positions look efficient in calm conditions, even as they increase vulnerability to shocks.
Properly constructed diversification reduces portfolio fragility, mitigates tail risks and increases the probability of meeting long-term objectives across a wide range of market environments.
In every cycle in which equity returns are driven by a narrow dominant group of stocks, the same conclusion is reached: diversification has failed. However, what is rarely acknowledged is that this verdict is almost always delivered by investors whose definition of risk is essentially synonymous with equity volatility.
There is no universal definition of risk. It is a preference masquerading as a principle.
Equity concentration rewards being right; credit concentration is built around not being wrong.
Equity portfolios are structurally asymmetric. Upside is theoretically unlimited, while downside is tolerated in exchange for growth. Concentration amplifies this asymmetry: when the world evolves in line with expectations, equity concentration appears visionary.
Credit portfolios are constructed on an entirely different premise. Upside is capped. The dominant risk is permanent capital loss. Success is defined not by participation in narratives, but by avoiding error, especially correlated error.
Equity concentration is a bet on how the future will unfold. Credit diversification is a bet on how wrong you can afford to be.
This distinction is not just stylistic. It reflects two fundamentally different philosophies of capital allocation.
Diversification in equities reduces noise, in credits it preserves the portfolio
Within equities, diversification primarily eliminates idiosyncratic noise. However, market risk, valuation risk and liquidity risk remain fully intact. When correlations rise, as they reliably do, equity diversification offers comfort rather than protection.
In credit, diversification is existential. Default risk is binary. Recovery values are path-dependent. Correlations do not need to converge for damage to be permanent. A poorly diversified credit portfolio does not merely underperform, it breaks.
This is why credit investors obsess over issuer exposure, capital structure and downside scenarios, while equity investors debate narratives, multiples and thematic dominance. These are not cultural differences. They are consequences of payoff geometry.
The real heresy: diversification is not meant to maximise returns
“Diversification is not a tool to maximize returns”, is a claim that consistently makes investors uncomfortable.
Rather, it is a risk-control mechanism designed to prevent catastrophic misallocation when the future refuses to cooperate with consensus expectations. It exists to protect against regime shifts, correlation breakdowns, liquidity shocks and false certainty, none of which appear in performance tables until they matter most.
Therefore, judging diversification by its ability to keep up with a narrowly driven equity index is a category mistake. It evaluates a forward-looking uncertainty framework using backward-looking outcomes.
When it comes to managing equity funds, balanced portfolios and credit strategies, diversification is less about being right and more about remaining solvent, flexible and investable when conditions change.
That may not be exciting. But it is effective.
Equity investors talk about opportunity cost, credit investors talk about survival
When equity concentration underperforms, the cost is relative: missed upside, benchmark regret and narrative discomfort. When credit concentration fails, however, the cost is absolute: impairment, write-downs and permanent capital loss.
As a result, equity investors naturally view diversification as a drag on returns. Credit investors view diversification as an existential risk. Neither view is wrong, but confusing them leads to flawed portfolio construction.
The modern diversification debate often assumes that all capital behaves like equity capital. This assumption is rarely articulated and almost never challenged.
Balanced portfolios are not equity dilution.
In balanced portfolios, credit is often treated as a lower-volatility equity, a yield sleeve rather than a structural counterweight. This interpretation, while convenient, is wrong.
Credit reshapes the distribution of outcomes. It alters drawdown dynamics, improves cash-flow visibility and preserves reinvestment optionality during periods of market stress. Its role is not to smooth volatility, but to ensure that capital remains available for deployment when markets reprice risk.
Diversification across equities and credit is not about averaging returns. It is about avoiding dependence on a single economic narrative.
Equity logic dominates because equities have won
The dominance of equity-centric thinking in diversification debates reflects a long period in which growth, liquidity and valuation expansion have consistently rewarded equity risk.
However, extrapolating this experience into a general rule would be a classic regime error.
When optimism is abundant, credit does not look compelling. However, it becomes indispensable when optimism is wrong.
Diversification is an admission of uncertainty, and this is its strength
Equity concentration and credit diversification offer different solutions to the same question: how much uncertainty can you afford?
Declaring that diversification is obsolete because equities have rewarded concentration is not an insight, it is an extrapolation. And extrapolation, dressed up as conviction has a poor long-term track record.
Diversification is not dead. It simply cannot coexist with an equity-only worldview, especially during a period when the worldview feels so comfortable.
Diversification across asset classes is a core principle in balanced portfolios. By combining equities, fixed income and cash, balanced strategies aim to manage uncertainty, reduce dependence on a single market outcome and preserve flexibility across market cycles.
- East Capital Multi-Strategi – a diversified multi-asset strategy combining equities, fixed income and small cash position.
- Espiria 30 – a balanced strategy with a lower equity allocation and a focus on risk control
- Espiria 60 – a balanced strategy combining growth potential with diversification across asset classes
- Espiria 90 – a multi-asset strategy with a higher equity allocation within a diversified framework
