Investing for Non-Correlation: Reduce Your Risk and Increase Your Returns

Investing for Non-Correlation means investing in assets whose prices and investment performance do not relate to or change with the securities markets.  Non-correlating assets can be any asset that does not move in concert with the market whose systematic risk it is trying to be avoided, e.g. bonds, currencies, commodities, real estate, etc.  These non-correlating assets possess their own behavior and change based upon the supply demand situation, fundamentals or technicals of the security itself; not the broad capital markets.  Non-correlated investing reduces systematic risk.  Systematic risk is the risk inherent to an entire market (stock market, bond market, currency market, commodity market, etc.) or market segment, industry, etc.  Systematic risk can be measured using beta and can only be reduced by hedging, or asset allocation including investing in non-correlated assets.

For example, In the small cap and micro cap equity markets, non-correlating stocks can be identified.  These stocks will trade based upon the their own respective supply demand situation of the security and/or their own fundamentals and technicals.  They will not trade in concert with the S&P 500, NASDAQ Composite or even the Russell Microcap Index.  In this example, the benefits are that systematic risk is largely reduced.  Not completely obviated but definitely mitigated, such that the performance of the broad markets is not the performance of the securities selected.

Another example of a non-correlating asset within the equity markets consists of PIPE investments.  PIPE is an acronym for Private Investment [in] Public Equity.  These are investments made via a private placement (private offering) in a security which is different than, but possesses an underlying publicly traded security.  Investment terms and pricing for PIPE investments are different than that of their underlying public security and therefore their valuation and behavior is also different.  Usually 6-12 months later when these securities become unrestricted, they can be sold as a freely trading security of the underlying equity or convertible equity.

Non-correlating assets reduce market risk (beta) and have the potential to generate much larger than market-related investment returns (alpha).

By |2019-01-30T15:20:00+00:00January 30th, 2019|blog|0 Comments