Diversification and correlation

LOWERING CORRELATION

In such volatile times, the road to recovery is one that must be watched closely, as flexibility to adapt to potential changes can prove vital.

One of the first pieces of advice investors are given is the importance of having a diversified portfolio. The rationale is that if the returns on your assets are subject to different drivers, then weakness in one asset should not necessarily be reflected in weakness across the whole portfolio. The most important contributor to the diversification effect of an asset is the correlation to the rest of the portfolio: the lower the correlation, the more diversifying the asset. Experience tells us correlations change over time, but over the last few years we have seen a sharp increase in the ...