Just because two funds represent different industries does not mean that they are they are not well correlated. Allocating your money into assets or asset classes that are highly correlated will be far less beneficial than putting your money into asset classes that are not correlated with one another. Many of you have read all of this before, but read on. There is a source of correlation between assets that most people are unaware of called nonsystematic correlation—and more correlation means that a portfolio is more risky.
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They’re not the sexiest property on the Monopoly board, but in today’s market, there’s plenty of evidence mounting that utilities are a great source of income. Gluskin Sheff’s David Rosenberg made the case for utilities in his September 6 commentary. Taking a contrarian view, Rosenberg acknowledged that utilities are universally disliked by Wall Street analysts and have performed poorly relative to other sectors this year. But utilities offer a 4.2% yield – nearly twice that of the market....they deserve a substantial...
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Here’s a little-known fact: The traditional 60/40 portfolio, when using the aggregate-bond index for its fixed-income allocation, has a 99% correlation to the returns of the S&P 500. Rob Arnott pointed this out in 2004, and it remains true today.

One way to overcome the limited diversification value offered by the aggregate index is to use a risk-parity approach. In this article, I explore the concept of risk parity in asset allocation and how it provides value for portfolio management.
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Bill Gross of PIMCO forecasts a New Normal - slow economic growth, higher inflation, and increasing correlations among asset classes. If this view is correct, what should investors do? Geoff Considine examines the implications for asset allocation and financial planning by stress-testing some well-known asset allocations to see how well they will serve investors in the forecast environment.
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Bill Gross made headlines in February by asserting that U.S. Treasury bonds were not providing enough yield to make them worth the risk and reducing his allocation to zero in the PIMCO Total Return Fund (institutional share class PTTRX). The subsequent rally forced him to admit his mistake in August, but by then his fund was trailing 90% of its peers and having its worst year since 1995. I will examine Gross’ February decision in retrospect, to illustrate its tactical and strategic costs and benefits for his shareholders.
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The last decade severely tested investors’ belief in the value of diversification and strategic asset allocation, leading some in the financial media to assert that diversification and asset allocation failed and were worthless during the crash of 2007-2008 (see, for example, here). Now is an ideal moment to look back and assess the carnage.
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Few problems facing financial planners have been as extensively studied as sustainable withdrawal rates (SWRs). Today, the conventional wisdom holds that a 4% SWR is reasonable, given a traditional 60/40 approach. But higher SWRs can be achieved in a number of ways, and the last chapter in the search for better deaccumulation planning is yet to be written.
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The devastation caused by the crash of 2008 was not limited to individual retirement portfolios. The endowments of most prominent universities suffered terribly, causing many of these institutions to drastically slash budgets and cut back planned capital spending.

Yale may have the most respected investment acumen, thanks to its manager, David Swensen, who is credited with developing the “endowment model,” a paradigm he has refined over his quarter-century tenure at the university. Yale’s performance during the 2008 crash was far from stellar, however, leading many to question the validity of the assumptions that underlie the endowment model.
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Many investors seem to be in the process of losing faith in asset allocation. In September and October of 2008, it seems that all asset classes have moved together—straight down. The positive benefits of asset allocation rely upon certain asset classes having low correlations with one another—when one dives, others don’t. While correlations tend to go up during fairly short periods of panic selling in crashes, the value of managing a portfolio using asset allocation has been consistently demonstrated. In this article, we present a useful data point in this regard.
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The concept of diversification is often discussed, but I am increasingly of the opinion that many investors do not understand diversification at a deep level. This is unfortunate, because diversification is the one ‘free lunch’ in investing. Indeed, this was the genius of Harry Markowitz in showing that combining asset classes in a thoughtful way allowed investors to generate higher returns without increasing risk in their portfolios. On a practical basis, what does this mean for investors? How much more return can investors generate by being well diversified?
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At the heart of investing theory is the idea that investors can generate more return with less risk by combining assets in the portfolio that are not well correlated with one another. Weakly correlated assets tend to damp out total portfolio risk to some extent without decreasing return—and this is the value of diversification.
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Combining Strategic and Tactical Asset Allocation

In a recent article, I discussed Tactical Asset Allocation [TAA] and its relationship to Strategic Asset Allocation [SAA]. To take advantage of both TAA and SAA, it is necessary to build a highly diversified portfolio that has a projected future return that is greater than the returns that the portfolio has generated in recent years (i.e. the assets in the portfolio have generated less-than-expected returns in recent years). The recent under-performance means that the portfolio is due for a reversion to the mean and provides the potential for a performance boost beyond long-term expected returns (the TAA component). The core Strategic Asset Allocation ensures that the portfolio derives the maximum available diversification benefit and has a total volatility that is consistent with the needs of the investor(s).
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...The defining objective of a market-neutral portfolio is that its returns have low correlation to the broader market. Investors use such funds as a diversifier to their other investments in equities. Low-correlation between assets improves their diversification value. In practical terms, increased diversification means that you can achieve a higher return for the total amount of portfolio risk.
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I have been working in the utilities industry since 1999, principally as a consultant. Because of my work with energy utilities as well as my firm’s focus in equity analysis, I have spent considerable effort analyzing utilities as investment opportunities. While utilities have traditionally been regarded as fairly boring investments, the last decade has brought substantial changes that have revitalized the utilities industry. Utilities have delivered superior returns in recent years, along with the rest of the energy industry. Part of the investor interest in utilities derives from the fact that we are in a commodities boom and many classes of ‘hard assets’ have been performing well, but utilities have some special features for investors that bear consideration in determining the appropriate allocation to this sector.
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Whenever I read interviews with Warren Buffett and Charlie Munger or the commentary provided for investors in Berkshire Hathaway, I am struck by the fundamental common sense that Buffett and Munger bring to issues of economics, investing, and policy. Buffett and Munger have repeatedly noted that given uncertainty in tax laws, currencies, regulations, and political stability, a desirable way to invest in foreign markets is to purchase stocks in U.S. companies that have substantial foreign sales in local currency. In recent years, Berkshire Hathaway (BRKA) (BRKB) has been investing more heavily and directly in foreign firms, but BRK’s equity holdings clearly show the philosophy of gaining international exposure by buying U.S. firms with strong foreign sales. Coke (KO), Anheuser Busch (BUD) and Procter & Gamble (PG) all have large and growing international sales and these are top equity holdings in BRK.
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One of the most central, but misunderstood, topics in asset allocation is portfolio diversification. Everyone talks about diversification as though it is an easy thing to achieve, but many of the portfolios that I see in articles and submitted to us by our clients demonstrate that many people—professionals and individual investors alike—do not fully understand diversification. The simple idea behind diversification is easy enough to grasp: you don’t want all of your investment eggs in one basket. For this reason, investors are advised to put their money into a range of asset classes at various allocations.
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Awhile back there controversy here at Seeking Alpha after Michael Panzer posted an innocuous chart of iShares Emerging Markets (EEM) vs iShares MSCE EAFE (EFA) suggesting that the performance gap between EEM and EFA was narrowing. I’ve found that the solution to most problems in life is muddy up the water, and statistics are great way to do that. Thanks to data from Yahoo Finance and software from SPSS (SPSS), I've drawn some conclusions about the relationships among SPX, VIX, EFA, EEM.
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