Asset Class Correlations are rising, and it’s a problem

Posted on: 06/18/2015

While reading an article recently on Yahoo! Finance about the “macro fatigue” that many investors are facing today–amidst the incessant reports of Greece collapsing and anticipation of when the Fed will finally decide to raise rates, I stumbled upon this little nugget referring to how hard it is to diversify among the different market segments:

“With correlations so high, how do you adequately diversify a portfolio of financial assets?”… Answer: “You can’t.”

You can’t? Well let me tell you that you certainly can adequately diversify an investment portfolio, even in the face of, as we call it here at iSectors, “Correlation Convergence” of traditional asset classes. How? Well, if traditional asset classes’ correlations are converging towards 1.00, then the only logical thing to do would be to use “untraditional” asset classes whose correlations are not converging on 1.00. Simple enough, right?

But not so fast! Which asset classes exist that aren’t correlated to each other? How does one find those investments? The good news is that iSectors has already done this research and implemented it in two managed ETF portfolios, the iSectors Post-MPT Allocations. We have plenty of other posts pertaining to the Post-MPT models on our blog, so I won’t go into too much detail about them in this post. However, as it relates to the asset classes (or sectors) utilized in the Post-MPT models, the data below paints a pretty clear picture of the differences in correlations of traditional and untraditional asset classes:

isectors-corr

traditional corr

*Data obtained from iShares Correlation Calculator

This data should speak for itself.  You can most definitely diversify a portfolio of financial assets; you just need to break away from traditional thinking and think in a more untraditional way.

 

Note: Vern Sumnicht has written a more thorough post on correlation, read it here.



Leave a Reply

You must be logged in to post a comment.

%d bloggers like this: