2nd Discipline – Inverse Correlation

INVERSE CORRELATION simply means that in any given market cycle, not all asset classes behave similarly. Oftentimes they rise and fall inversely to one another. Therefore, by investing in pairs of asset classes, we can use INVERSE CORRELATION to help reduce volatility in a portfolio.

However, in most portfolios INVERSE CORRELATION is not fully utilized. Either it is perceived too broadly – in terms of cash versus bonds versus equities, or it is grouped into simply the four major equity categories; large-cap, mid-cap, small-cap and international.

In addition, advisors and investors tend to look at recent performance records and buy from the best performing funds. In other words, they buy high. With a clear understanding of INVERSE CORRELATION, we help clients buy low instead.

If utilized to its fullest potential, INVERSE CORRELATION allows us to help minimize risk without sacrificing return potential.

Any two asset classes that have a high INVERSE CORRELATION have much less volatility than a single asset class. We have carefully researched the historical performance. We have tracked the actual and average smallest and greatest discrepancies between each pair of major asset classes. When an inversely correlated pair of asset classes achieves a percentage spread just below its historical average, we rebalance. This is how our second and third disciplines work in tandem to achieve minimal volatility with maximum return.

In keeping with the objective nature of our system, it is important to note that we are not predicting the future. We have analyzed the past to a greater degree than any money manager we have ever encountered. Our intensive analyses regarding the average INVERSE CORRELATION across each of the twelve asset classes allows clients to capture the positive opportunities inherent to the known volatility of the equity markets. We have never met another institution, advisor or money manager who has executed this level of research and has the freedom – through Capacity – to act on it.