Asset Class Correlation In January 2019

Feb. 01, 2019 9:01 AM ETBLV, BIV, BSV, SPY, AVEW, VWO, VNQI, VNQ, DBC-USD, GLD-USD4 Comments2 Likes
Roberts Berzins profile picture
Roberts Berzins
1.36K Followers

Summary

  • All of the asset classes (excluding bonds and gold) were closely correlated.
  • Short term bonds have exhibited a negative correlation to almost all the other asset classes.
  • Since the market has developed positively, the benefit of diversification has been rather modest during Jan 2019.

January 2019 has been a decent month for almost all asset classes. During this month none of the ETFs mentioned below and used to reflect the performance of the underlying asset classes provided a negative return. All of the asset classes (excluding bonds and gold) were closely correlated. ETFs that track stock markets have exhibited a very strong linear relationship – close to 1. Commodities, which are considered a high beta asset class, have behaved similarly as real estate and stocks. However, bonds and gold at the same time haven't had so strong linkage to the overall market performance. For instance, the correlation matrix for short term bonds shows a negative correlation to almost all the other asset classes.

Source: Author, based on Yahoo finance

In general, the relationship between VIX and major asset classes is the following – whenever the market volatility spikes considerably all indices tend to fall accordingly. Historically, bonds and gold have shown the strongest resistance against the spikes in volatility. January 2019 confirms this thesis.

The line graph below depicts how the market has responded to the movements in VIX (right axis). All of the ETF prices have increased, while VIX has fallen significantly. Gold has shown the strongest resistance to the changes in VIX.

Source: Author, based on Yahoo finance

Bonds, similar as in the correlation matrix above, have shown least co-movement with the VIX. While the VIX dropped almost 40%, all of the bond types showed a stable development.

Source: Author, based on Yahoo finance

The bottom line

Since January has been a stock friendly month, in which all of the reflected asset prices have increased, the benefit of diversification was rather modest. Safe asset classes as bonds and gold have once again shown their diversification effect resulting in smaller correlation coefficients to the market sensitive positions (e.g. real estate, stocks, and commodities). Short-term bonds have performed with even negative linear relationship.

Indices used

In order to reflect the performance of each of the aforementioned asset classes, I have chosen the largest (based on total assets) ETFs associated with the asset class in question. The goal of the selected ETFs is to reflect the performance of the underlying asset class as closely as possible. However, the reader should be informed that it is impossible to avoid region, sector, holding and weighing bias, which is automatically inherent in a benchmark that seeks to track any asset performance. Single commodities can be considered an exception in this case. To see how the ETFs respond to volatility spikes (whether they follow the market linearly), I compare them to the CBOE volatility index – VIX.

Gold - SPDR Gold Trust (GLD). It tracks the spot prices of gold bullion (physically-backed gold, where the underlying assets consist of gold bullion stored in secure vaults).

Commodities - Invesco DB Commodity Index Tracking Fund (DBC). This ETF is used to achieve broad-based commodity exposure. It tracks DBIQ Optimum Yield Diversified Commodity Index Excess Return and the top 3 holdings were WTI crude, Brent crude, and heating oil.

Source

Real Estate (U.S.) - Vanguard Real Estate Index Fund (VNQ). This ETF offers exposure to U.S. property trusts that covers about two-thirds of the value of the entire U.S. REIT market. VNQ follows the MSCI US REIT Index, which has just over 100 holdings diversified primarily across mid and large-cap equities, while exposure to small-caps is also abundant.

Real Estate (ex-U.S.) - Vanguard Global ex-U.S (VNQI). Real Estate ETF. This ETF offers exposure to global real estate markets, excluding American securities mostly in favor of assets in either Europe or the Asia Pacific region.

Source

The benchmark index is S&P Global ex-U.S. Property Index.

Emerging Markets - Vanguard FTSE Emerging Markets ETF (VWO). This Fund seeks to track the performance of the FTSE Emerging Index, an index of large and mid-cap companies in multiple emerging markets in Europe, Asia, Africa, Central and South America and the Middle East.

Source

Developed Markets (ex-U.S.) - Vanguard FTSE Developed Markets ETF (VEA). This ETF offers exposure to developed markets outside of North America, including Western Europe, Japan, and Australia.

Source

The benchmark of this fund is FTSE Developed All Cap ex US Index, a market-capitalization-weighted index that is made up of approximately 3,790 common stocks of large-, mid-, and small-cap companies

SP500 - SPDR S&P 500 ETF (SPY). The investment seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the S&P 500 Index.

Source

Short-term bonds - Vanguard Short-Term Bond ETF (BSV). This ETF offers exposure to the short end of the maturity curve, with exposure to all types of bonds that have maturities between one and five years. It tracks Barclays U.S. 1-5 Year Government/Credit Float Adjusted Index (includes all medium and larger issues of U.S. government, investment-grade corporate, and investment-grade international dollar-denominated bonds that have maturities between 1 and 5 years and are publicly issued).

Intermediate-term bonds – Vanguard Intermediate-Term Bond ETF (BIV). It seeks to track the investment return of the Bloomberg Barclays U.S. 5–10 Year Government/Credit Float Adjusted Index, a market-weighted bond index that covers investment-grade bonds with a dollar-weighted average maturity of 5 to 10 years.

Long-term bonds - Vanguard Long-Term Bond ETF (BLV). This ETF offers exposure to the long end of the maturity curve, with exposure to all types of bonds that have maturities greater than 10 years. It seeks to track the performance of the Bloomberg Barclays U.S. Long Government/Credit Float Adjusted Index.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

This article was written by

Roberts Berzins profile picture
1.36K Followers
I have worked in the finance industry for 6 years, gaining experience particularly in financial reporting as well as in financial and credit analysis. Currently, I am responsible for risk management.My genuine interest in finance began from the opportunity of visiting the Chicago Board of Trade and talking there with a soybean trader. Our rather brief, but the enlightening conversation was an eye-opener for me. I understood that in order to perform well, I have to be constantly involved in the industry and keep myself updated of what´s happening in the economy, politics etc. This requirement of being on your toes was and still matches my personality. From that moment I have been constantly trying to shape my craft in finance by participating in CFA program (currently CFA Level II candidate), following new accounting standards and reading financial news on daily basis. My portfolio consists of stocks and cash. Cash/Stock ratio is determined based on the current market valuations and near/mid-term recession risk. Stocks that are included in the portfolio are always chosen based on their relative and historical valuation levels. Strong FCF and stable revenues coupled with a high probability of price stimulating catalyst event are mandatory characteristics for my stock selection.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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