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Asset Correlation – Why It Is Important Asset correlation is a measurement of the relationship between two or more assets and their dependency. This makes it an important part of asset allocation because the goal is to combine assets with a low correlation to each other. The correlation measurement is expressed as a number between +1 and -1. A zero correlation indicates there is no relationship between the assets. A +1 indicates an absolute positive correlation (they always move together in the same direction). A -1 indicates an absolute negative correlation (they always move together in opposite directions of each other).
Positive Correlation When two or more assets move up and down together. Stocks in the same industry would have a high positive correlation. They would probably be affected similarly by events.
Zero Correlation When two or more assets show no relationship to each other. Combining multiple assets with no correlation, like real estate and stocks, would be an ideal diversified portfolio because volatility (risk) of the whole portfolio would theoretically be minimized. In the real world most assets have some correlation; so a low asset correlation such as between gold and S&P stocks, would be a good example of near non-correlated assets.
Negative Correlation When two or more investments move inversely to each other they have negative correlation. Two assets that were perfectly negatively correlated would eliminate risk of the combined assets.
Please contact Tom Cooper to discuss correlation, risks and diversification themes for you portfolio.