You may think your portfolio is diversified and you may be
right or you may be wrong. In defense of
your diversification strategy, you may point to how various asset classes have
interacted over time. That’s really nice
and it might make you feel good, but you may need to look deeper.
Below is a chart on 3-Year Rolling Correlation to US Stocks
using monthly Morningstar Direct data. If
you are confused on what “Rolling” is, here
is a quick summary:
When something is said to be rolling it's tracking a certain amount of time in the past, and then rolls forward as time progresses. So the 3 year rolling correlation would be the correlation between stocks and another asset for the past 3 years. Next month, we add one more month (current month) and subtract the last month from the prior calculation.
Basically this is any easy way to smooth out the data so you
can see how various asset classes have moved over an intermediate time-period.
One thing that sticks out to me is the increased correlation
over time of equities – Developed Market Stocks, Emerging Market Stocks, and
REITs. Thus, having a diversified equity
portfolio holding these asset classes would do little to combat a fall in
Domestic Equities. Commodities of late
have also not proven to be the diversifier they once were, though currently this
is starting to breakdown.
The takeaway is to be diversified
for the current market environment. Diversification still entails the
strategic longer view of markets, but it also requires a tactical shorter-term analysis
in order to be diversified and minimize portfolio volatility. If you are diversified given the correlations
of the past, you could be in for a rude awakening.
Past
performance is no guarantee of future results. Diversification does
not guarantee a profit or protect against a loss. The views and opinions
expressed herein are those of the author(s) noted and may or may not represent
the views of Capital Analysts, Inc. or Lincoln Investment.
