The first rule of thumb for investors is to diversify, but portfolio managers today take that one step further.

Sophisticated investors, such as those on the management-end of endowments and foundations, may be accustomed to the “risk factor” asset allocation model.

Rather than diversification by asset class, portfolio managers shield against risk by diversifying risk budgeting in a variety of different areas.

“We look at diversification by looking at risk factors of the portfolio and they are, global rates, credit, equity, inflation and currency,” said Jeff Scott, chief investment officer of Wurts and Associates, an institutional advisory firm that provides outsourced CIO services. Scott noted “equity risk” is derived from an equity risk premium and advocated prudence in following the measure.

Yet, many managers employ equity diversification via a dispersion of managers. “Forty-two” managers, said Scott, is not diversification, just “giving the index less active management fees.”

“In 2008 and 2009, what we weren’t doing was on the forefront of thinking and that gave us an opportunity for us to make changes,” Scott said. “Portfolios were receiving a healthy dose of mean variance, and that really means that diversification was stagnant.”

Scott refers to the post-modern portfolio theory, which uses the standard deviation of negative returns as the measure of risk, and thereby, focuses on downside protection.

For many mangers, the norm is to follow the modern portfolio theory, uses the standard deviation of all returns as a measure of risk.

Capturing downside protection is paramount, at a time with markets are struggling with a “risk on and risk off” environment, according to Nicholas De Monico, chief executive of marketable alternative strategies, at the Commonfund Asset Management Company.

“The big picture philosophy is diversification and managing risk; what’s changed is the ways in which we look at that,” noted Arvin Soh, investment manager at GAM, an provider of alternative investment management strategies. Soh manages a global macro, managed futures portfolio.

“Diversification now is much more than by asset class, or geography—it’s trade construction, size of manager, time frame for investing…it’s about whether or not we covered all the angles in a lot of different ways.”