Definition of correlation

To talk of a correlation is to express the strength of the relationship between two variables. A correlation is said to be positive if movements between the two variables are in the same direction and negative if it moves in the opposite direction. A correlation of zero means there is no correlation at all between the two variables.

Investment managers are interested in correlation in a portfolio because they do not want the value of all investments to fall simultaneously. Instead the ideal is to find investments which perform differently in different investment climates. Traditionally an investment manager might have been able to achieve this simply by investing in bonds and equities – in risk averse investment climates investors would buy bonds, encouraging bond prices to rise, and in times when investors felt more confident about future performance they would raise their exposure to equities. However, during the 2008/2009 financial crisis most asset classes performed equally badly.

Investment managers and central bankers are also interested in the correlation between other variables that can give a clue to future price direction. For example, in December 2013, An FT writer pointed out the declining correlation between energy and non-energy inflation.

 

correlation in the news

In December 2013 Mark Haefele, global head of investment at UBS Wealth Management, writing for FT Alphaville spoke about the increasing correlation between commodities and other investment strategies. He pointed out that the correlation between commodity and other asset price changes was near 20 per cent in the 1980s and 1990s, but that the correlation had grown to 60 per cent.

In January 2014 the FT's John Authers examined the declining correlation between stocks and the metals market in the video below: