# There is no such thing as uncorrelated markets. Discuss



## PubMan (28 Feb 2007)

I have been gradually getting into investing over the past year, investing a substantial sum of money in a fairly diversified basket of 6 ETF. (the usual suspects, EU, US, Emerging, Japan, small stocks) However what I've been somewhat surprised at has been the correlation of all the markets (both on their way up and down)

Is it possible to build a stock portfolio nowadays with zero or negative correlation?

What should I be looking at to add some market diversification to my portfolio , property funds, commodities or gold (shudder)?

Any comments would be welcome


----------



## ClubMan (28 Feb 2007)

PubMan said:


> Is it possible to build a stock portfolio nowadays with zero or negative correlation?


What does this mean? That your stocks stay at a constant value or that they go down when markets go up or what!?


----------



## tiger (28 Feb 2007)

Maybe another question is why has the share price drop in China affected my European/US shares & is there something else I could have invested in that would not have been affected by this event?


----------



## ClubMan (28 Feb 2007)

Equities are always going to exhibit transient volatility on a (hopefully) long term upward general trajectory. Trying to avoid volatility doesn't make much sense to me.


----------



## PubMan (28 Feb 2007)

ClubMan said:


> What does this mean? That your stocks stay at a constant value or that they go down when markets go up or what!?



No. I am asking if you can have a portfolio in which not all elements track each other (= closely correlated). ie China goes south and so does practically every other market in the world. I thought I was clear in the original question. Obviously not.


----------



## ClubMan (28 Feb 2007)

Well the bottom line is that nobody can predict the future so the answer would have to be "no" as far as I can see.


----------



## RedJoker (28 Feb 2007)

According to portfolio theory, market risk (systematic risk) will always be present. However, diversifying across many markets can reduce this but not to 0.

In answer to your question, world stock market risk is present and undiversifiable by adding more stocks. To reduce portfolio risk you should add other investments such as bonds, property, etc. 

All of this is of course theoretical.


----------



## silvamuppet (28 Feb 2007)

PubMan. Diversify more. I.e consider bonds and maybe even property. Bonds and equities tend to move in opposite directions (to a certain extent, to the best of my knowledge?).

With regard to sticking with equities if you favour a contrarian investment strategy as advocated by the likes of David Dreman (see his book "Contrarian Investment Strategies: The next generation") where you stick with low PE stocks these tend not to get moved too much by bad news in the market as is happening now. They will go down. But by quite small amounts. And assuming they are good companies when they bounce they will bounce big. The current round of blood letting on the markets will hit the high and medium PE stocks the hardest in general!


----------



## PubMan (28 Feb 2007)

ClubMan said:


> Trying to avoid volatility doesn't make much sense to me.


Really? It does to me. 

If you reach retirement age and the one market you had invested in was in the middle of a major downturn, would it not have made sense to have invested also in a second market with zero/negative correlation?


----------



## ClubMan (28 Feb 2007)

PubMan said:


> Really? It does to me.


Perfect negative correlation between two assets means that your money stands still. Riding out volatility in selected markets/assets etc. will usually result in your money growing over the long term.


> If you reach retirement age and the one market you had invested in was in the middle of a major downturn, would it not have made sense to have invested also in a second market with zero/negative correlation?


 If you were nearing the time at which you were going to draw down pension benefits then you should have already done an advance preparatory shift into something like cash or bonds to avoid volatility. That's what most _PRSA _(and other?) pension default investment strategies aim to do for example.


----------



## demoivre (28 Feb 2007)

PubMan said:


> Really? It does to me.
> 
> If you reach retirement age and the *one* market you had invested in was in the middle of a major downturn, would it not have made sense to have invested also in a second market with zero/negative correlation?



Investing in one market for your retirement would be a very imprudent approach to take imo.  For real diversification of one's wealth investing  among different asset classes is crucial as well as sector diversification within equities .  might interest you regarding ETFs.


----------



## shanegl (28 Feb 2007)

PubMan said:


> I have been gradually getting into investing over the past year, investing a substantial sum of money in a fairly diversified basket of 6 ETF. (the usual suspects, EU, US, Emerging, Japan, small stocks) However what I've been somewhat surprised at has been the correlation of all the markets (both on their way up and down)
> 
> Is it possible to build a stock portfolio nowadays with zero or negative correlation?
> 
> ...


 
What reading I've done on the subject suggests that globalisation has increased correlation between world markets. I dont see a better alternative to the strategy you're pursuing though. Maybe add some sort of REIT ETF? I think you'll be able to trade these on the LSE soon too.


----------



## Taximan (28 Feb 2007)

It’s hardly that surprising that there is a high correlation between large indexes based ETF’s; most of the companies that make up these indices will be large global multi's. So it stands to reason that the markets will follow each other in the modern global economy. In a nutshell if the US Sneezes we all get the Flu. 

As a previous poster stated you need to diversify your asset selection this should improve the covariance of your portfolio. You also need to stock pick and not just buy an index. This is all very easy in theory but in practise not quite so. In the global economy you are highly unlikely to find major markets that diverge that much it might take a couple of hours to catch up but it will get there.  

The best money mangers I have seen or read about are quite often short on Portfolio theory and big on Gut. They understand what the man in the street thinks before he acts on it. That been said the theory is fun for us lesser mortals to justify are often inadequate trading strategies.


----------



## darag (28 Feb 2007)

Clubman said:
			
		

> Perfect negative correlation between two assets means that your money stands still. Riding out volatility in selected markets/assets etc. will usually result in your money growing over the long term.


Not necessarily; the expected return and volatility are different aspects of the behaviour of asset prices.  You're looking for two assets with negatively correlated volatility, not negatively correlated growth.  Both assets can be volatile (with negative correlation) and growing.  The trick, according to Modern Portfolio Theory is to pick a portfolio where the volatility of the assets cancels out as much as possible without affecting the overall growth of the portfolio.  Google for "efficient frontier".


----------



## ClubMan (28 Feb 2007)

darag said:


> You're looking for two assets with negatively correlated volatility, not negatively correlated growth.


True - I stand corrected.


----------



## macbri (7 Mar 2007)

If you are looking at eliminating volatility/risk,then 1 strategy would be to take out put options on shares that u buy.

I will give u loan I took out as an example.

I have taken out a $250k protected portfolio loan here in Australia at a fixed rate of 14.5% over 3 years.
Basically at the end of loan period if my shares come to less than my initial purchase price,I don't pay loan back as the bank has taken put options on shares at purchase price-hence the interest rate at 14.5%.
My maximum loss is interest rate that I pay.

Shares that I have picked (all australia)currently pay average of 10% dividend and I get extra tax relief on interest/put options in 3 years time. 

I have worked out in cash flow terms,protected portfolio loan will only cost me $7k pa-less if dividends increase pa and beauty of this is I can put my remaining cash assets into non volatile investments.

I realise this product may not be available in Ireland but buying put options are a good way of managing volatility providing u know what your doing


----------

