Morningstar has published their (, but free with email), another useful whitepaper for DIY investors that looks closer at the correlations between different asset classes. The first three sentences quoted below are important:
The problem is that correlation coefficients shift over time, so what worked in the past won’t necessarily work in the future. In addition, adding asset classes to reduce volatility can also drag down returns, sometimes over multiyear periods. Moreover, correlations between many assets spike during periods of market crisis—in other words, exactly when you need diversification the most. The catalysts for crisis periods that lead to equity-market declines can also vary dramatically. Macroeconomic stress can drive declines (as it did during 2008 and early 2020), but so can rising interest rates, geopolitical uncertainty, and so on. Those underlying conditions can have an impact on which diversifiers fare best.
In this paper, we dig into the diversification benefits of adding various assets to a U.S. equity portfolio, including taxable bonds, municipal bonds, international equity, commodities, alternatives, sector-specific indexes, investment styles, factor indexes, and cryptocurrency.
I’m not very interested in correlations over a recent 1-year timeframe, but I am interested in stepping back and seeing how asset classes behave over longer periods of time.
The lower the correlation between asset classes (the less they move in the same direction), the greater the reduction in volatility you get by combining assets. As long as you combine asset classes with correlations below 1, you get some degree of volatility reduction.
Here are a few selected charts from the research paper, along with my quick takeaway.
Takeaway #1: In terms of diversification benefits, staying as safe as possible is still the way to go. The best is still US Treasury bonds. Even the popular US “total bond” indices which include corporate bonds have shown positive correlations with stocks at times.
Takeaway #2: High-quality muni bonds have also kept their correlations negative, but high-yield “junk” muni bonds spike at the exact wrong time (market crashes).
Takeaway #3: International stocks offer a little diversification benefit, but are usually strongly correlated with US stocks. You must have faith that international stock returns will at times exceed US stock returns for periods of time to invest in this asset class.
Takeaway #4: Commodities go through boom and bust cycles as part of their nature, and the correlations with US stocks can also stay high or low for years at a time. I find it all very unreliable and unpredictable.
Takeaway #5: Gold has shown a consistently low correlation with US stocks. For myself, it’s not the correlation I’m concerned with, but the long-term returns.
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