A guide to uncorrelated asset allocation

Experienced investors understand the benefits of diversification: blending a range of asset classes will make their portfolios less vulnerable to sudden shocks. The hope is that should stock markets take a tumble, holdings in other areas, such as bonds, will offer some protection. It is worth examining whether your portfolio is properly diversified, or if there is a risk that your investments could move in the same direction at once.

Here we take a look at how to know if your asset allocation is properly balanced and suggest some funds that could make the task less stressful.

What are uncorrelated assets?

Uncorrelated assets behave differently to one another because their values aren’t influenced by the same factors. A company’s share price, for example, will be affected by broader stock market movements, economic factors, as well as the reaction of analysts to its results.

In contrast, the returns on commercial property are based on a combination of a building’s value and the rental income it generates. Tenant demand and the level of interest rates will be more influential and therefore it can play a different role in a portfolio.

Investment grade or government bonds will behave differently again. They tend to do well when interest rates and inflation are falling, and are often a safe haven when stock markets are weak.

Pursuing an asset allocation strategy that blends uncorrelated assets is the equivalent of not putting all your eggs in one basket.

Dangers of correlation

The danger of having a correlated portfolio is that you risk losing a significant portion of your portfolio if everything you own ends up in freefall at the same time. This is not as unlikely as it sounds. The technology bubble, for example, saw those that had bet too heavily on a single asset class lose a large chunk of their savings.

Of course, diversification is not always entirely predictable.

There will be certain scenarios when even carefully constructed, diversified portfolios don’t end up affording the anticipated protection. Recent examples include the global financial crisis and Covid-19 pandemic, when pretty much everything was adversely affected.

However, you can give yourself the best chance of avoiding significant sell-offs by building a balanced portfolio.

Is your portfolio correlated by stealth?

Here we take a look at the hidden ways in which your portfolio’s assets may be correlated:

• • Basic asset split: Do you have too much of your portfolio in equities? Is this how you want to be positioned or is it by accident? If it’s the latter, then consider bonds, property and maybe some alternatives.

• • Regional exposure: Do you have too much of your money exposed to a particular region? For example, you may own five different funds but if they’re all focused on Asia Pacific, there’s a clear imbalance.

• • Investment style: Funds can also be correlated in their broad approach. For example, if you are mostly positioned in growth-oriented portfolios, your portfolio may struggle if the market turns against this style.

• • Properties and equities: Property is a popular diversifier for equity investors – but only if they’re investing in actual bricks & mortar, as opposed to the shares of property-related companies. If not, they will behave like equity holdings.

• • Being global – but not diversified: You may have opted for a handful of global funds in the hope that this will give you broad diversification. However, they may all be invested in the same stocks, so make sure you check.

• • Similar sector exposure: Another form of stealth correlation. You may have collected large cap funds from across the world, but missed the fact they are all heavily weighted in a handful of sectors.

How to avoid correlation

Diversification is key to mitigating risk in your investment portfolio, and avoiding asset correlation is a crucial part of this strategy. To achieve this, spread your investments across different asset classes with low or negative correlations. By combining assets with diverse performance patterns, you can reduce the impact of market fluctuations on your overall portfolio. 

Alternatively, you could opt for a multi-asset approach, in which those at the helm are responsible for deciding the appropriate asset allocation mix.

Five multi-asset funds to consider

Rathbone Strategic Growth Portfolio 

This multi-asset fund focuses not only on returns, but also on risk and correlation. Manager David Coombs uses a disciplined asset-allocation framework and a forward-looking assessment of correlation, risk and return, as the cornerstone of the investment process. It has around 60% in equities, 17% in government bonds, 7.5% in alternatives, and almost 7% in corporate bonds, as well as commodity and private equity exposure*.

Jupiter Merlin Balanced Portfolio

The investment objective of this fund is to achieve capital and income growth on a medium to long-term basis, with a balanced approach to risk. This is a well-managed fund of funds, where up to 30% of the fund may be invested in other assets, including shares of companies or cash. Jupiter offers a number of funds within their Merlin range, which are managed by a highly experienced team of professionals. Learn more about them in this interview.

Ninety One Global Income Opportunities

The objective of this fund is to provide income, along with the opportunity for capital growth, over five years. It invests conservatively around the world in a diverse range of equities and bonds, as well as some exposure to other assets. Asset allocation decisions start from an equity-centric position. If attractively-valued equities can be found, the allocation in equities will be taken towards the top of the permitted range. It also has a current yield of roughly 3%**.

M&G Episode Income

This multi-asset fund invests directly in individual stocks and bonds, while property exposure is gained by investing in property funds. The name “Episode” refers to those periods of time when investors’ emotions cause them to act irrationally. The manager uses behavioural finance to find pockets of value and invest against the herd, rather than following it. This contrarian option offers something unique for any portfolio.

BNY Mellon Multi-Asset Balanced

This aims to strike a balance between income and capital growth over the long term. This is defined as being at least five years. The fund’s manager, Simon Nichols, has created a global multi asset vehicle that uses themes to target the forces driving global change in markets. The fund remains focused on companies that have more resilient earnings profiles and attractive end-market outlooks.

Research all Elite Rated multi-asset funds

Remember: regardless of whether you choose individual stocks and funds or a multi-asset fund for your portfolio, it’s important to reassess and rebalance your portfolio regularly to maintain the desired asset allocations, helping to safeguard against unforeseen correlations that could threaten your financial goals.

*Source: fund factsheets, 30 November 2023

**Source: fund factsheet, 31 December 2023