Correlation is one of the most widely used statistical measures in modern finance. But investors looking for genuine portfolio diversification may wish to use it alongside other metrics as they look to mitigate risk.
Read this article to understand:
- The limitations of relying solely on correlation to assess portfolio risk
- Why other metrics such as an asset’s beta can help aid portfolio construction
- Why the ongoing threat of inflation points to the continued need for true portfolio diversifiers
To gauge whether to add a new asset, such as an alternative strategy, to a traditional multi-asset portfolio, investors will typically look at its correlation to the other assets already held. By identifying funds with low or negative correlation to bonds and equities, the aim is to boost diversification, reduce downside risk, and improve risk-adjusted returns.
However, headline correlation, which is a statistical measure showing whether two or more variables are directionally related and the strength of that relationship, only provides so much information.
While it is one of the most widely referenced metrics in modern finance, correlation does have limitations when used in isolation. By considering other metrics, it is possible to gain a clearer insight into the diversification potential of adding a new alternative asset to a multi-asset portfolio.
For a start, correlation estimates are based on historical data, and relationships can and do change over time. Perhaps more importantly, they say nothing about how much one asset is likely to move in relation to another.
Headline correlation also provides limited information as to how a strategy is likely to perform across different market environments. For example, two funds with similar long-term correlations can deliver very different results during periods of market stress.
And since correlation is measuring the strength of a linear relationship between two variables, it misses non-linear relationships.
Strengthened decision-making
To add depth to the decision-making process, investors may wish to also consider an asset’s expected sensitivity to overall market conditions. For instance, when considering shifting some of their allocation out of bonds and into alternatives, they may want to look at the alternative asset’s beta, or sensitivity, to changes in equity markets, not just its correlation to them.
In an ideal world, an alternative strategy would be non-linearly related, offering asymmetric correlation
They may also want to know if the correlation of the new asset under consideration has tended to change according to the market environment and, if it has, understand why. After all, in an ideal world, an alternative strategy would be non-linearly related, offering asymmetric correlation – positively correlated to equities during market rallies and negatively correlated when they are falling.
The ultimate aim should be to get a better understanding of whether an alternative strategy is likely to offer meaningful diversification when it matters most – during drawdowns.
Aviva Investors’ AIMS fund has since inception, on average, delivered a rolling three-year correlation of 0.6 to global equities and an overall beta of 0.2, the latter metric meaning it typically captures about 20 per cent of an equity market rally.
Yet these headline figures conceal important differences, notably over the last five years. On closer inspection we see that during rising markets the correlation was 0.33, with a beta of 0.19, while in falling markets correlation fell to 0.11 and the beta to 0.06.
To illustrate this, we have plotted the fund’s weekly returns versus global equity markets over the last five years in Figure 1.
Figure 1: AIMS fund’s return profile - convexity in action, 5-year weekly return data (per cent)
Past performance is not a reliable indicator of future results.
Note: Returns are based on weekly data in GBP.
Source: Aviva Investors, Bloomberg. Data as of November 30, 2025.
This asymmetry of returns, clearly visible in the curved, or convex, trendline, demonstrates the fund has offered participation in rising markets with resilience through some challenging market conditions. This convexity of returns is a defining feature of AIMS and shows why it has the potential to be an effective portfolio diversifier.
This pattern is not an anomaly. Since inception over ten years ago, AIMS has consistently demonstrated an ability to preserve capital and, in many cases, deliver positive returns during severe equity market drawdowns as seen in Figure 2.
Figure 2: AIMS drawdowns have been limited during equity sell-offs (per cent)
Past performance is not a reliable indicator of future results.
Note: Maximum drawdown is shown gross of all fees and may be reduced by applicable costs and charges, in GBP, for AIMS Target Return. Inception date July 1, 2014. Global equities represented by the MSCI All Country World Equity Index (local currency). Ten worst rolling 3-month equity declines since fund inception as measured by the preceding 3-months to date shown on x-axis.
Source: Aviva Investors, Morningstar. Data as of November 30, 2025.
No coincidence
Neither is AIMS’ resilience a coincidence. It stems from the way the portfolio is constructed. While some of its strategies are designed to capture traditional risk premia in both equities and bonds – explaining the fund’s positive overall correlation to equities, its stability comes from risk-reducing strategies that offset this risk. These strategies have since inception contributed more than ten percentage points to the fund’s overall return.
In 2025, risk-reducing strategies were the key driver of AIMS’ convexity. The standout position was in equity-index put options. It was designed to profit from market complacency over the threat of higher US tariffs.
When global equities plunged more than ten per cent following President Trump’s “Liberation Day” announcement, the price of these put options climbed sharply, which meant this was the most profitable position across the portfolio over the course of the year.
Managers look to generate returns by exploiting market dislocations and thematic opportunities
The managers also look to generate returns by exploiting market dislocations and thematic opportunities such as relative-value trades, and systematic and volatility strategies. These opportunistic strategies can further boost resilience and diversification, since their performance tends to be independent of market direction.
At a time when virtually all asset prices have been marching higher in lockstep, thanks in large part to renewed easing of monetary conditions, investors could be forgiven for downplaying the need for building diversified portfolios.
But the events of 2022, when central banks were forced to hike interest rates aggressively to combat inflation, should serve as a cautionary reminder of the dangers posed by highly correlated markets.
While inflation may have declined appreciably from its peaks set in 2022 and 2023, it remains well above levels seen prior to the pandemic. Should it take off, investors could be exposed to the threat of bonds and equities falling simultaneously once again as central banks jacked up interest rates.
In such a scenario, alternative investments could act as a useful portfolio diversifier, as was the case in 2022, when in many instances they provided valuable ballast to multi-asset portfolios.
