The Benefits of Uncorrelated Alpha.
One of the biggest virtues of trading or investing, is diversifying your risk. In the search for performance it is always advisable to have diversity in your investments. Not have everything pointing in one direction. That is easier said than done. Correlations are a tricky thing, and investors must pay attention and not let them sneak-up and create havoc.
The excess liquidity inundating markets creates quite a kerfuffle. That distorts the landscape and now, more than ever, one must pay attention to their overall portfolio risk. Is it all the same trade? Has risk management been diluted to a point that you can buy anything knowing that the FED has your back? It sure seems that way, but the fact of the matter is that it is not. And to make matters more intense, correlations matter significantly more on the way down, than on the way up.
Correlations Chart: SPX, Crude and AUDUSD
How will these assets do on a correction lower? Is this true diversification?
Having diversification in your portfolio is not easy, and sometimes it may not be pleasant. It implies that there will be underperforming assets, and the justification is simple; they are being held as a hedge. But is that the most efficient tool of portfolio construction?
The real benefit of managing a balanced portfolio is, in our humble opinion, finding uncorrelated alpha. This means having assets that perform under any regime, with results that in no way correlate to each other or the rest of the portfolio. One common mistake is to find negatively correlated assets. The idea is to find assets with no correlation. The Foreign Exchange market is ideal for that.
Chart of the SPX Index, EURCNH (Euro vs offshore delivered Chinese Renminbi), and AUDCAD (Australian Dollar vs. Canadian Dollar).
The perfect storm is when you suss out the source of alpha which creates an enhanced portfolio. It is not simple, and it requires active management, but it is worthwhile. Finding the right team and the proper style of management is critical. The answers are out there, it is just a matter of finding them.
Oscar G. Salem
Founder, Managing Partner
BCM Partners, LLC