Skip to Main Content

Asset correlation – How does it impact your investment portfolio?

Trying to understand all the aspects of asset correlation? Click here to understand how asset correlation impacts your investment returns and asset allocation of your investment portfolio
Asset-correlation-–-How-does-it-impact-your-investment-portfolio

Asset classes take turns to outperform

The decade 2000-2010 was the “golden” decade for gold investors. The gold price jumped from around Rs. 5,000 / 10 grams to around Rs. 25,000. If you had invested heavily in gold during this period, your wealth would have multiplied five times. However, the following decade 2011-2020, was not that great for gold investors. The price of gold went up from around Rs. 25,000 / 10 grams to around Rs. 55,000 / 10 grams. If you had invested heavily in gold during this period, you would have only doubled your money in 10 years. Hence, as an investor, you need to diversify your investment portfolio in various asset classes. More importantly, these asset classes should ideally have zero or negative correlation so that you can make optimal risk-adjusted returns on your investment. In this article, we will understand what asset correlation is and how it impacts your investment portfolio.

What is asset correlation?

Asset correlation is the process of measuring how the price of one asset class moves in relation to the price of another asset class. For example, assume you have asset classes such as domestic equity, gold, fixed income, and international equity in your investment portfolio. Asset correlation will measure how the price of domestic equity moves in relation to the price of gold, fixed income, and international equity. Similarly, with asset correlation, you can measure how the price of gold, fixed income, or international equity moves in relation to the price of the other three asset classes in the investment portfolio.

Types of asset correlation

Asset correlation can be of three types: Positive, negative, or zero correlation.

Positive correlation

When the price of two asset classes moves in the same direction, whether up, down, or sideways, they are said to be positively correlated. For example, if the price of gold and domestic equity is moving up together, the two are said to have a positive correlation.

Chart: Positive correlation

From 2003 to 2007, the Indian and US equities had a bull run. So, domestic equities and international equity had a positive correlation during this period.

2. Negative correlation

When the prices of two asset classes move in opposite directions, they are said to be negatively correlated. Crude oil prices and domestic equities usually have a negative correlation.

Chart: Negative correlation

3. Zero correlation

When the price movement of one asset class doesn’t have any impact on the price movement of the other asset class, they are said to have zero correlation. Fixed income is a steady asset class and usually has zero correlation with domestic equity.

Chart: Zero correlation

What should be your asset allocation?

Now that we understand asset correlation, let us understand which asset classes you should include in your investment portfolio. Some of these include:

  1. Equity mutual funds
  2. Debt
  3. Gold

Let us look at the correlation between these asset classes.

Correlation between equity, debt, and gold

Note: The above data is for the last 20 years (April 1998 to March 2021). Equity is represented by Nifty 50, debt by Nifty 10-year benchmark G-Sec, and gold by the spot rate for 10 grams.

The above table shows how in the last 20 years:

  1. Equity had a negative correlation with debt (-0.25) and gold (-0.05)
  2. Debt had a negative correlation with equity (-0.25) and gold (-0.09)
  3. Gold had a negative correlation with equity (-0.05) and debt (-0.09)

As all three asset classes have a negative correlation with each other, an investor should have all three classes in their investment portfolio.

Nifty 50 and gold correlation

In the above section, we saw how equity and gold had a negative correlation in the last 20 years. Now let us understand this correlation in more detail.

Chart: Nifty 50 and gold correlation

The above chart shows:

  1. During 2010-2014, the Nifty 50 was subdued, and gold did well. 
  2. From 2014 to 2020, the Nifty 50 did well. But, gold was subdued during this period. 
  3. In March 2020, the Nifty 50 crashed due to the Covid-19 pandemic. During this uncertain period, gold did well, as it is considered a safe haven during uncertainty. 
  4. Later, in 2020 and 2021, the Nifty 50 had a sharp recovery. During this period, gold underperformed.

Nifty 50 and debt correlation

The above section shows the negative correlation between Nifty 50 and gold. Now let us look at the correlation between Nifty 50 and debt.

Chart: Nifty 50 and debt correlation

Note: The fixed deposit rates are for SBI 1-year FD

The above chart shows during the 30 years (January 1991 to March 2020), there was almost no correlation between the Nifty 50 and the SBI 1-year fixed deposit. The FD amount kept moving steadily at its own pace. On the other hand, the Nifty 50 had many bouts of short-term volatility. If an investor had both asset classes in their investment portfolio, the fixed deposit allocation would have helped cushion the Nifty 50 volatility. However, in the long run, the Nifty 50 beat the fixed deposit by a handsome margin. 

Correlation between Nifty 50, S&P 500, and NASDAQ 100

In the last few years, there has been a lot of interest among Indian investors in investing in international equities, specifically the US markets. Let us look at the correlation between the Nifty 50, S&P 500, and NASDAQ 100 indices.

Chart: Nifty 50, S&P 500, and NASDAQ 100 correlation

The above chart shows that during the six years (August 2015 to August 2021), the Nifty 50, S&P 500, and NASDAQ 100 indices had a positive correlation. However, the extent of the correlation varied widely.

If an investor invested Rs. 1 lakh in each of the three indices, then:

  1. The Nifty 50 index multiplied investor wealth by 2.31 times
  2. The S&P 500 index multiplied investor wealth by 2.83 times
  3. The NASDAQ 100 index was the biggest outperformer and multiplied investor wealth by 4.26 times.

For asset allocation to work, asset correlation is the key

In the above sections, we have seen how the Nifty 50 had a positive correlation with the S&P 500 and NASDAQ 100. But, the correlation was not a perfect 1:1. We also saw how the Nifty 50 had a negative correlation with gold and no correlation with debt. Hence, you need to build an investment portfolio with asset classes with negative or no correlation. Even if the correlation is positive, the correlation should be low. To conclude, if you want to earn optimum risk-adjusted returns along the asset allocation, the key is asset correlation.

Investing in mutual funds with the Glide Invest App

In this article, we have discussed what asset correlation is and how it impacts your investment portfolio. You can partner with the Glide Invest App for your financial planning journey to get recommendations for the appropriate mutual fund schemes based on your risk profile. You will get advice on planning and systematically investing towards your financial goals

With Glide Invest, you will get guidance for:

  1. A personalised risk profile assessment
  2. Identifying your financial goals
  3. Appropriate asset allocation
  4. Making a financial plan for each goal
  5. Automating the financial plan
  6. Review and analysis of your financial plan 
  7. Hand holding you till your financial goals are achieved

To start investing towards your financial goals, download the Glide Invest App from Google Play Store or Apple App Store and get started.

Click to start searching
Recent Posts
John Templeton’s Investing Lessons: What You Should Know
7 minsNovember 29, 2022
The Little Book of Common-Sense Investing Book Review
9 minsNovember 25, 2022
Optimizing the number of mutual fund schemes in your portfolios: how to do it?
11 minsNovember 22, 2022
Investing Lessons you Must Learn from the Game of Football
5 minsNovember 18, 2022
Investments in credit risk funds: what should you know?
9 minsNovember 15, 2022
Posts by Categories
International Investing (3)
Glide Portfolio (3)
Tech (3)
Passive Investing (7)
Goal Planning (9)
Investment basics (10)
All Stash! (10)

Like What You See? Want to learn the simple ways to make investment stress-free?

Sign up for our newsletter & get the best expert advice & news around the financial world

We won’t annoy you more than once a week, Pinky Promise!

John Templeton’s Investing Lessons: What You Should Know

How can you pick multibagger stocks and become a successful investor? To learn more about investing tips from Sir John Mark Templeton, click here!

The Little Book of Common-Sense Investing Book Review

How do index funds differ from other stocks and mutual funds? Read here to learn more about it from Sir John C Bogle’s Little Book of Common Sense Investing.

Optimizing the number of mutual fund schemes in your portfolios: how to do it?

Is there a ideal number of mutual fund schemes in a portfolio of investments? For more information on optimizing your mutual fund investment portfolio, click here.