How to Build a Portfolio with Low-Correlation Assets | The Secret to Reducing Risk and Increasing Returns

                                     

       

[The Core of Diversification: Building a Portfolio with Low-Correlation Assets]

       

In the world of investing, the saying, 'Don't put all your eggs in one basket,' has long been an important guide for investors. This highlights the importance of diversification, and one of the core strategies of diversification is to build a portfolio with assets that have low or negative correlation with each other.

   

   

Reducing Risk and Increasing Returns: How to Build a Portfolio with Low-Correlation Assets

   

1. Why are Low-Correlation Assets Important?

   

The correlation between assets is an indicator that shows how similarly the price movements of two assets move. A correlation coefficient close to 1 means the two assets move in almost the same direction, while a coefficient close to -1 means they move in opposite directions, and a coefficient close to 0 means their movements are independent of each other.

   

The main reasons for including low-correlation assets in a portfolio are as follows:

   

       
• Risk Reduction: This is the most crucial reason. When the value of a specific asset falls, the value of another low-correlation asset may rise or remain relatively stable, which can reduce the overall portfolio's loss. In other words, one asset's uncertainty is offset by another, which has the effect of lowering overall volatility.
       
• Stabilization of Returns: When volatility decreases, the portfolio's returns can also be maintained more stably. This prevents the entire portfolio from taking a severe hit during periods of extreme market downturns, contributing to the achievement of long-term investment goals.
       
• Improvement of Risk-Adjusted Returns (Sharpe Ratio Improvement): You can expect higher returns for the same level of risk, or lower risk while maintaining the same return. This is a very important factor in building an efficient portfolio.
   

                            

---

   

2. Which Assets Have Low Correlation?

   

The following are typical combinations of asset classes that have traditionally shown low correlation:

   

       
• Stocks and Bonds: Stocks generally react sensitively to corporate performance and economic growth, while bonds are more influenced by interest rate changes and are often perceived as safe-haven assets. When the economy is unstable and the stock market declines, bond prices tend to rise, acting to mitigate each other's volatility.
       
• Domestic vs. Export-Oriented Stocks: Industries or types of companies that may fare differently depending on economic conditions can also be a good combination. For example, export-oriented companies whose profitability changes with currency fluctuations may show different trends from companies that focus on the domestic market.
       
• Developed Markets and Emerging Markets: Since capital flows differ depending on global economic conditions, developed and emerging markets can sometimes show different movements.
       
• Specific Commodities (Gold, Crude Oil, etc.) and Other Assets: Commodities categorized as safe-haven assets like gold can be used as an inflation hedge or their value can increase when market uncertainty grows, resulting in low correlation with other assets.
   

   

---

   

3. Example of an Actual Portfolio

   

Investors can combine various asset classes according to their risk tolerance and investment goals. For example, there is the Permanent Portfolio, which I posted about in another article. Aggressive investors can increase the proportion of stocks but mix stocks with different characteristics, such as technology stocks, value stocks, and growth stocks, or include both domestic and international stocks. Investors who prefer stable investments can adjust the ratio of stocks to bonds and, if necessary, add alternative investment assets such as REITs or infrastructure funds to create a more diversified portfolio.

   

▶Go to the Permanent Portfolio article

      

---

   

4. Conclusion: The Interaction Between Assets

   

When building a portfolio, while the individual value of each asset is important, understanding and utilizing the interaction between assets, i.e., correlation, is crucial for long-term investment success. By appropriately combining low-correlation assets, investors can increase the stability of their portfolios and pursue more efficient returns even in unpredictable market conditions.

   

        Key Summary:
        The diversification strategy of combining low-correlation assets is important to reduce portfolio risk and improve returns. A stable portfolio can be constructed by utilizing asset classes with different characteristics, such as stocks and bonds, or domestic and international stocks.    

   

       

The contents of this blog are for reference for investment decisions only, and investment decisions must be made under individual judgment and responsibility. Under no circumstances can the information in this blog be used as legal evidence for investment outcomes.