Why are so many asset classes correlated and impact on AA?

[Olav23]

I have noticed there seems to be quite a correlation lately with most asset classes. I've heard this explained by everything from baby boomers withdrawing at the same time, china and middle east slushing around cash, LBOs/hedge funds etc...

My thought is that historical correlations have been very different from today sheerly because of a lack of easy investment vehicles into many harder-to-find asset classes. Today, you can find an ETF for any class you can think of including derivatives and shorting/bear funds. I've even heard word that they might make an ETF based on some Art index!

Do you all agree that ease of access is why the correlations are starting to line up? And if you buy into this argument, do you forsee any reason to change asset allocations based on this?

Everyone and his mom can basically go to smartmoney/ameritrade/vanguard, enter their age and risk profile and get a generic portfolio which is basically inline everyone else and their mom. So, if we are all in the same asset classes, in roughly the same percentages based on historical correlation matrices, is it some kind of self fulfilling prophecy that we'll all underperform, and at the same time, match each other?

Sorry for the babbling, but wanted to get my idea out while it was fresh in my mind.

 

[Bimmerbill]

Interesting discussion. I am just starting to look at correlation among my investments. I'm in a financial analysis and decision making class and we briefey touched on the subject.

I am trying to work the numbers in a spreadsheet but with little luck so far.

Stocks and bonds are negatively correlated, right?

 

[d]

i have noted that international equities have been increasing in correlation with domestic equities ... thus decreasing the diversification benefit, coincidentally while many are increasing their international exposure.

 

[Brat]

The correlation issue has had me thinking too, as I mentioned in another thread. The only way I can get a handle on this is to look at the ETFs Leader Board on Bob's Ponies http://customer.wcta.net/roberty/index.html

When all else was in the dumps lately only utilities stayed green. Need I remind that you really need to look at the holdings and parameters in an ETF, as in mutual funds. The wrapping sometimes doesn't match the contents.

 

[Animorph]

I've been thinking along the lines of easy access too, but that might hold only for short-term variations.

Over longer periods, economics must have some say in the price, although globalization seems like it might correlate that to some extent. Still, I don't think we're quite at the point where every country is in complete lockstep.

My other idea was to start using broader market sectors, like energy or health care, as part of the AA. They are large enough that they are not going to just disappear, and should go their own way to some extent.

It does seem hard to find much with returns similar to the larger market but uncorrelated to most of it.

Dan

 

[ats5g]

Do you all agree that ease of access is why the correlations are starting to line up? And if you buy into this argument, do you forsee any reason to change asset allocations based on this?

No. You can check out correlations going back to 1990 here.

- Alec

 

[haha]

No. You can check out correlations going back to 1990 here.

- Alec

I believe that most of the correlations that are taken for granted by retirees, prospective retirees, and their advisors are likely spurious or temporary at best. Slicing and dicing worked very well around the turn of the millenium, because some classes and subclases were inflated, some quite cheap.

If all or almost all asset classes are levitating in unison as they have been since 2003 there must be some common fuel under the rise. If/when the flow of that fuel is withdrawn or just lessens we might expect all the assets whose rise was stimulated by the excessive fuel to lose altitude more or less simultaneously.

My nomination for the fuel during the past few years is worldwide credit expansion. Historically credit expansion is limited by people’s ability to service the debt.

Bon appetit!

Ha

 

[MasterBlaster]

Ha:

Also the rise of hedge funds which often take large contrary position(s) in the market. This helps everything move in lock-step.

Add in world-wide nervousness about overbought highly leveraged asset classes and when there is an event then everything gets sold off.

This last sell off was really weird in that things like the US dollar and gold also sold off. traditionally these have rallied while equities and bonds stumbled.

historically that's a very unusual occurance.

Is it different this time, or will things revert back to their expected performance ?

- Stay tuned,

 

[lswswein]

Correlations change all the time. Some asset classes might be highly correlated for a few months and some for yrs. The question do you care about short term increase in correlation, if in the long term they stay at an acceptable level. Also at what stage would you drop an asset class for being too correlated?

-h
p.s: I remember berstien on efficient frontier has some good articles on this