Diversification is key to Portfolio Management but using Correlation alone may not be enough
Many investor’s Risk Management approach is based on diversification. We believe diversification is the holy grail of investing, but only when done right and put in the proper context. Often times it is oversimplified, especially to the general investor. Many are taught just to buy many different asset classes and just hold them through up and down markets.
In reality, correlation which is the foundational principle behind diversification is misinterpreted. Many investors wrongly believe that the correlation between assets is stable over time. This is one of the assumptions of Modern Portfolio Theory. But our research shows that the correlation between asset classes evolves over time based on the economic environment.