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What correlation tells you
- +1.0: assets move identically.
- 0: assets are unrelated.
- −1.0: assets move exactly opposite.
- Most asset-class pairs sit between 0 and +0.7 over long periods.
Why correlation matters for diversification
Combining assets with low correlation produces a portfolio with lower volatility than the average of the components — the foundational insight of modern portfolio theory. Two assets with 50% correlation, equally weighted, produce a portfolio with substantially less than the average volatility of the components.
Correlation instability
- Correlations measured in calm markets are not the correlations that materialize in stress.
- Equity correlations approach +1.0 during sharp drawdowns — diversification within equities provides little protection in crashes.
- Stock-bond correlation flipped from negative to positive during the 2022 inflation episode, surprising portfolios that assumed it would stay negative.
- Alternative-asset correlations to public markets are often higher than published numbers suggest, particularly in stress.
What advisors should monitor
- Stress-period correlations, not just average correlations.
- The stock-bond relationship in different inflation regimes.
- Whether "alternatives" in the portfolio actually behave alternatively, or just track equity in different wrappers.
- The correlation matrix's stability over rolling periods.
Correlation and concentration
A portfolio of 30 stocks looks diversified by name count but may be concentrated by correlation if all 30 are large-cap U.S. growth stocks. Concentration risk is best assessed through correlation, not just position weight.
How StratiFi thinks about correlation
Correlation is one of the most assumed and least examined numbers in portfolio construction. The firms that hold up under examination check whether the diversification they're describing to clients survives the scenarios that matter — stress periods, regime shifts, liquidity events — rather than relying on the long-term-average correlation matrix that papers over the worst weeks.
Frequently asked questions
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What's a "good" correlation for diversification?
Lower is better, but practical limits exist. Most asset pairs sit between 0 and +0.7 in normal markets. Truly negative correlations are rare and often unstable. -
Why do correlations rise during crises?
In stress, investors sell what they can — not what they want — driving previously unrelated assets to move together. The phenomenon is documented across major market events; it is the rule, not the exception. -
Are stocks and bonds always negatively correlated?
No. Stock-bond correlation has shifted between negative and positive across decades, depending on whether inflation or growth is the dominant macro variable. The 1970s and 2022 saw positive correlation; most of the 2000s saw negative correlation.