The purpose of asset allocation is to own minimally correlated assets, which tends to reduce portfolio volatility while delivering the return of the blended classes.

Within the major equity category, asset classes are often thought of as US, non-US developed, and emerging country stocks.

Correlations between those major categories have converged somewhat in the past, but in 2008  they approached unity.

If equity class correlations equal “1″ there is no allocation benefit relating to diversifying the volatility within the equity class.

This correlation table for 1-year returns for various Vanguard mutual funds (with ETF proxies for those mutual funds) shows major and minor equity categories lining up in 2008 with correlations approaching “1″.

Securities listed in image:
VFINX, VTSMX, VFWIX, VDMIX, VEURX, VPACX, VEIEX,
SPY, VTI, VEU, VEA, VGK, VPL, VWO

Asset allocation with regard to equities will work better when correlations begin to diverge.

Richard Shaw
QVM Group LLC

This entry was posted on Wednesday, January 7th, 2009 at 8:47 pm and is filed under Asset Allocation, Developed Markets, Emerging Markets, Europe, Market Conditions, US Stocks. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.