Correlations For Return Volatility Have Spiked

For a broader perspective, let’s run the numbers on all the ETF proxies for the major asset classes, based on the following funds:

The table below shows that the volatility correlations are high for all the asset pairings, based on a trailing one-year window as of Dec. 28.

The key message: volatility correlations remain high across the board. It’s reasonable to assume that vol-corr will slide in the months ahead. Whether we see a return to the “normal” level of correlations is debatable. By some accounts, markets overall have become closely linked in the pandemic and this tight connection will endure.

If so, the opportunities for tapping into diversification’s benefits by holding long-only, standard asset classes will diminish in some degree. On that basis, investors have two basic choices as responses. One, grin and bear it and recognize that multi-asset class portfolios will be more volatile and subject to a higher level of tail risk than history implies.

The second choice: work harder to maintain a certain level of diversification by expanding the opportunity set into so-called alternative asset classes and/or adding tactical measures to the mix. Neither choice is a riskless proposition, but holding a multi-asset-class portfolio comes with higher risk these days, too. Pick your poison.

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Disclosure: None.

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