We all know the standard warnings that ‘the value of your investments could go up or down’.

It’s true – there are no guarantees with investing, but not everything in a portfolio moves in the same direction at the same time. If it does, you need to diversify.

Non-correlated assets are an essential part of effective diversification, generating better returns and protecting your clients’ portfolios from nasty shocks. They enable clients to reap the benefits of investments that perform well, while lessening the impact of those that don’t.

So if you want to optimise your clients’ portfolio balance, here’s what you need to know.

1. Adjusting the safety net – correlation and non-correlation

While past performance isn’t a reliable guide to the future, correlation is still a useful metric. It works on a scale with assets holding a plus or minus score. A score of +1 shows perfect positive correlation – two assets moving completely in step, while -1 represents perfect negative correlation – they move in opposite directions all the time.

A score of zero, meanwhile, means the assets are non-correlated, having no effect on one another. These are the ones that provide investment portfolios with a safety net.

Of course, it’s not as binary as that. Values are influenced by many different factors, so perfect correlation, or no correlation at all, is extremely rare. For example, gold traditionally shows low correlation with equities (which is why people ‘go to gold’) – it won’t be completely without correlation, but for the macroeconomic outlook the effect is small.

Achieve better diversification through non-correlation

Diversification is a pillar of investment, but it’s easy to get lazy. The ‘classic’ 60:40 portfolio has been the ‘smart blue blazer’ of investing for decades – it works for all occasions. But in recent years it has come under fire for being out of step with the times.

As investment professionals, we need to look beyond the obvious and read the landscape in which we’re operating. Focusing on investments that aren’t tied to current markets and looking to alternative investments gives clients a greater breadth of exposure and a better chance of riding out periods of volatility. Blending direct, traditional investments like real estate or stocks, with non-correlated assets such as life insurance and litigation finance builds a diverse portfolio with reduced risk and higher potential returns.

Blending direct, traditional investments like real estate or stocks, with non-correlated assets such as life insurance and litigation finance builds a diverse portfolio with reduced risk and higher potential returns.

2. Improving the overall risk and return ratio

Harry Markowitz’s 1952 essay Portfolio Selection laid the groundwork for Modern Portfolio Theory. In it he noted:

‘A portfolio with sixty different railway securities… would not be as well diversified as the same size portfolio with some railroad, some public utility, mining, various sort of manufacturing, etc.’

The paper goes on to argue that when a range of uncorrelated assets are put together, overall returns are improved and risk is lowered. The risk associated with individual investments doesn’t matter as much as ensuring that the risk is different to that of other holdings.

A robust portfolio needs a mix of complementary assets. If built from low- or non-correlated assets it won’t always produce gains, but it will allow investors exposure to the assets that perform well, while dulling the pain of those that don’t.

Take an intelligent approach to risk

Risk isn’t black and white. A straight-up low-risk portfolio might give safe but unsatisfactory returns, while a high-growth stocks portfolio could end badly. But a portfolio that invests in low and/or non-correlated assets builds a three-dimensional picture. As Charles Rotblut noted in his 2010 article The Benefits of Modern Portfolio Theory:

‘This moves the portfolio closer to the efficient market frontier by enabling it to benefit from several market forces instead of just one or two’.

Investment strategies with non-correlated assets that behave differently from stocks and bonds won’t rid your clients of risk. They will, however, spread it more intelligently.

Investment strategies with non-correlated assets that behave differently from stocks and bonds won’t rid your clients of risk. They will, however, spread it more intelligently.

3. Rebalancing and weatherproofing your portfolios

Asset allocation is not an exact science. But in general, low- or non-correlation between assets will increase the diversification benefit they bring to a portfolio. Remember – correlation is dynamic and won’t stay the same over time, especially during periods of market stress. Only by regularly rebalancing will you be able to reassure clients that their portfolios can weather the storm and maintain good returns.

Show clients that you have their back

While you’re here to help your client build a portfolio that matches their goals, it doesn’t hurt if they’re switched on to how skilful asset allocation can help them get there safely. Some clients are hands on, others are hands off. Either way, if they have an understanding of why you’re building the portfolio the way you are, it’s good for relations.

Either way, if they have an understanding of why you’re building the portfolio the way you are, it’s good for relations.

The internet is littered with posts about how to choose a broker, and of course having a client’s best interests at heart comes up a lot. By investing beyond the obvious you’re demonstrating that while you’re chasing good returns, you’re also thinking ahead and keeping them secure.

Building trust with your clients can help them to engage in and understand how risk and return really work.

A 360-degree approach

Investing on behalf of clients, you’re tasked with exploring all opportunities to make money, as well as all opportunities to cushion the blows of difficult periods. Adding non-correlated assets to the mix isn’t a magic bullet, but it’s an important part of your drive to achieve higher returns and lower risks.

Its effect is to allow participation in assets that perform well while deadening the negative effects of those that don’t.

It shows clients that you have a 360-degree approach to their wellbeing and it shores up the weak spots in their asset allocation. Again, that’s part of our job – it’s not just to drive forward, it’s to constantly have one eye on a rear-guard action.

That way you can achieve returns, lower risks, dampen setbacks and build trust.

About the author: Marco Saviozzi, CEO

Marco attained an MBA in Finance from the IEMI, Geneve, before starting his career in corporate sales at Xerox. He would eventually move on to French firm Viel (now Tradition), before being headhunted by prestigious London firm ICAP, where he was brought in as head of the French Franc IRS Desk. He quickly rose to become a part of the management committee as Co-Head of the Euro Desk, and later moved to the New York office to head up the Equity Derivatives team. After 14 years at ICAP, in 2007, he opened Newedge – a Calyon / Societe Generale brokerage arm in Dubai. Two years later he would go on to form GMG as a co-founder with several past colleagues. When he is not facilitating trades on behalf of clients, Marco can be found on the golf course or watching his favourites sports – Formula 1 and horse racing.