"...I hereby consign the shibboleth of 'uncorrelated return' to the scrap heap of asset allocation lingo, where it shall be available only to unscrupulous sellers, credulous buyers, and unschooled investment analysts."
-- Richard M. Ennis, executive editor, Financial Analysts JournalThese strong words from Ennis appeared in in his "Editor's Corner" entitled "The Uncorrelated Return Myth," Financial Analysts Journal (Nov./Dec. 2009).
Ennis asserts that "The notion of the existence of 'uncorrelated return' assets with handsome risk premiums flies in the face of financial theory and conflicts with empirical evidence."
When he says "financial theory," Ennis is referring to the capital asset pricing model, which accords positive risk premiums to market-correlated assets. He also says that evidence shows that so-called uncorrelated assets such as real estate, hedge funds, and private equity are actually highly correlated with the stock market.
What do YOU think about this topic?
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Susan B. Weiner, CFA
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Copyright 2010 by Susan B. Weiner All rights reserved
In the end, returns depend upon economic growth. You can't diversify away from that. And Siegel posits that there are only three real asset classes: real-estate, which derives rent; bonds, which are senior capital claims on the enterprise; and equity, which is the residual claim.
ReplyDeleteYou can diversify by enterprise, industry, and asset. But they all derive their economic value and return from the economy.
In the era of silo-ed economies it was possible to have uncorrellated returns. But as globalization and trade progresses, improving all economies, we pay for this increased growth in part by greater integration and an increase in diversified standard deviation, as correlations move up.
If we could invest in the economy of an extraterrestrial civilization, it would be uncorrelated. But all earth-bound markets are integrated today. And anyone who pulls out of the global network loses their Ricardan gains from trade, so their expected returns will be negative.
It's all just math and a little common sense.
Thanks for taking the time to comment, Doug. I wonder if we'll see an extraterrestrial ETF before long ;)
ReplyDeleteSimilar to Doug's opinion. Here is my way of expressing the situation. If the underline securities / assts are not normally price, then the correlation of these securities / assets could be low or negative. If a product includes these non frequent securities / assets, and the product itself is not price frequently, again the correlation could become low or negative.
ReplyDeleteIn another situation, if the market decides that tomorrow would have an unexpected surprise or correction, then assets would move in tandem.
What is correlation? If we could hold all events with equal status, it might be meaninful. However, in the real world, in my opinion, its meaningless.