What are non-correlated assets?


Investment decisions often revolve around the balance between risk and reward. While individual risk tolerances may vary, one common strategy to minimize potential losses is through diversifying investment portfolios.

One way to achieve diversification is by considering the correlation between different assets and creating an asset allocation that includes assets with negative or zero correlation.

## **Understanding asset correlation**

Asset correlation is a statistical measure that indicates how investments move relative to one another. It ranges from -1 to +1, where -1 represents perfect negative correlation and +1 represents perfect positive correlation.

In simple terms, assets that move in the same direction at the same time have positive correlation, while assets that move in opposite directions have negative correlation. Non-correlated assets are those that move independently of each other, with a correlation of 0.

![Illustration showing positive correlation, negative correlation, and no correlation](https://hedonova.b-cdn.net/Hedonova%20images/%20All%20Hedonova%20blogs/What%20are%20non-correlated%20assets%20need%20to%20revise/Correlations-min.webp)

## **Measuring asset correlation**

When two assets are non-correlated, the price movement of one asset has no impact on the price movement of the other asset. Various tools and resources are available to research asset class correlation using popular ETFs and asset class benchmarks.

It's important to note that correlation doesn't determine whether an asset will generate returns or not. However, having lower or negative correlation between asset classes in a portfolio can provide diversification benefits.

## **Correlation and modern portfolio theory**

The Modern Portfolio Theory (MPT) is an investment idea that suggests investors can create portfolios to maximize their expected return while managing risk. It emphasizes that taking on more risk can lead to higher potential rewards. MPT also proposes the concept of an "efficient frontier," which represents the optimal portfolios that offer the highest possible return for a given level of risk. Modern portfolio theory suggests that investors can reduce overall risk and potentially enhance returns by investing in assets with low or no correlation. When there is zero correlation, the movement of one asset doesn't indicate the movement of another asset. Negative correlation implies that while one asset appreciates, the other tends to decline, and vice versa.

![Illustration depicting the Efficient Frontier concept in Modern Portfolio Theory (MPT)](https://hedonova.b-cdn.net/Hedonova%20images/%20All%20Hedonova%20blogs/What%20are%20non-correlated%20assets%20need%20to%20revise/What%20is%20Inverse%20Correlation%204-min.webp)

By holding assets with varying degrees of correlation, investors can achieve relative success in the market without being overly dependent on a single asset class. This approach allows for potential returns while mitigating the risk associated with market volatility. Asset correlation measures how investments move in relation to each other. When assets move in the same direction, they are highly correlated. When they move in opposite directions, they are negatively correlated. If the price movement of one asset doesn't affect another asset's price movement, they are uncorrelated. In MPT, investing in assets with low or no correlation can reduce overall risk and increase returns.

In the cryptocurrency market, there is a high level of correlation among assets, making it challenging to use MPT to construct a portfolio on the efficient frontier.

## **Benefits of non-correlated assets**

There are several reasons why non-correlated assets are recommended by modern portfolio theory

**Portfolio Diversification:** A diversified portfolio includes a balance of asset classes, types, and correlation coefficients. By spreading investments across different asset classes, the impact of a decline in one asset on the entire portfolio is reduced.

**Risk Management:** Non-correlated assets provide a means of managing risk by offering alternative investment options that may not be influenced by the stock market's performance. This can help minimize losses during market downturns.

### **Risks associated with non-correlated assets**

Like any investment, non-correlated assets also come with risks

**Lower Liquidity:** Some non-correlated investments lack a readily available marketplace, making it challenging to sell the assets quickly without significant losses. Unique alternative assets may have limited liquidity compared to publicly traded equities.

**Asset Classes Not Correlated with the Stock Market:** While non-correlated assets offer diversification benefits, investors should carefully evaluate and understand the characteristics and risks associated with each asset class.

![Table displaying the correlation matrix of major asset classes from 1992 to 2020](https://hedonova.b-cdn.net/Hedonova%20images/%20All%20Hedonova%20blogs/What%20are%20non-correlated%20assets%20need%20to%20revise/Correlation%20Across%20Major%20Asset%20Classes%201992%20-%202020-min.webp)

## **Examples of non-correlated assets**

Several asset classes are commonly considered non-correlated. Here are a few examples

**Precious Metals:** Gold has traditionally exhibited a correlation coefficient of less than 0.5 with the stock market. It is often considered a safe haven asset that can act as a hedge against market fluctuations.

**Real Estate:** Real estate assets, including real estate investment trusts (REITs), have lower reactivity to economic news compared to traditional assets. They can provide diversification and historically perform well during inflationary periods.

**Commodities:** Commodities like oil, natural gas, and agricultural products often have low or negative correlation with the stock market. Their prices are influenced by factors such as supply and demand dynamics, geopolitical events, and weather conditions.

**Currencies:** Investing in currencies can provide diversification benefits, especially when paired with the investor's home currency. Forex markets offer opportunities to trade various currency pairs, and currency values can be influenced by economic factors and geopolitical developments.

**Cryptocurrencies:** Cryptocurrencies, such as Bitcoin and Ethereum, have emerged as alternative investment options with a low correlation to traditional financial markets. Their prices are driven by factors specific to the cryptocurrency ecosystem, including technological advancements, regulatory developments, and investor sentiment.

**Private Equity and Venture Capital:** Investments in private companies, startups, and venture capital funds can provide exposure to non-publicly traded assets. These investments have the potential for high returns but are typically illiquid and require thorough due diligence.

## **Conclusion**

Including non-correlated assets in an investment portfolio is a key component of risk management and diversification. By allocating investments across asset classes with low or negative correlation, investors can potentially reduce overall portfolio risk and enhance returns.

However, it's essential to conduct thorough research and understand the specific risks and characteristics associated with each asset class. Consulting with a financial advisor or investment professional can provide valuable insights and guidance when incorporating non-correlated assets into an investment strategy.


Non-correlated assets play a significant role in investment strategies, providing diversification and risk management benefits. Asset correlation measures how investments move in relation to each other, with non-correlated assets having a correlation of 0, meaning they move independently of each other. Modern Portfolio Theory (MPT) emphasizes the importance of including non-correlated assets to achieve optimal portfolios on the efficient frontier. Precious metals, real estate, commodities, currencies, cryptocurrencies, and private equity are examples of non-correlated assets. While non-correlated assets offer benefits like portfolio diversification and risk reduction, they also come with risks such as lower liquidity and the need for careful evaluation. Including non-correlated assets in an investment portfolio can enhance returns and reduce overall portfolio risk, but thorough research and consideration of each asset's characteristics are essential. Seeking advice from financial advisors or investment professionals is recommended for creating a well-balanced investment strategy.

What are non-correlated assets?

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