Expected vs. Unexpected News

Private payrolls were announced, showing that over 20 million people had lost their jobs. But, the market didn't react very much -- likely because this was an expected number. Check out this article at yahoo! entitled: Why Wednesday's historic jobs data was 'not really news'

Correlation Concerns

Modern Portfolio Theory (MPT) is based on the notion that diversification creates better (a.k.a., more efficient) portfolios. The benefit of the diversification stems from less than perfect correlations between asset classes. However, during times of extreme stress, and even in recent years with market integration, correlation values have increased. This calls into question whether diversification will bring the full benefit that it is expected to provide. See article here, Bloomberg.

Increased Leverage = Less Risk?

All else equal, the use of leverage increases investment risk. But, can it ever have the opposite effect? Investors using the so-called risk parity trade believe the answer is yes. Under this approach, a portfolio is built using equity and debt, but the debt is purchased using leverage. The strategy is based on two key points: (1) equity is more volatile than debt and (2) debt returns are negatively correlated to equity returns. Thus, with leverage, the debt returns are in effect more volatile. When combined, the negative correlation creates a less risky portfolio as the equity and debt returns balance each other out. See article here, Wall Street Journal.

Low Volatility ETFs

A recent trend is the development of low volatility funds, including both ETFs and mutual. These funds invest in a subset of a specified index, selecting only those stocks with low price volatility (which may be identified by a low beta). There is not sufficient history to gauge the performance of such funds, but two issues are worth noting. First, given the impact of volatility on compounded returns (i.e., geometric averages are lower than arithmetic averages), low volatility funds should have an advantage, particularly in otherwise volatile markets. Second, value funds may outperform over long periods (albeit not every period), and since value stocks are more likely to be low volatility, this may play a role in the performance. (See article here, Schwab.)

Is Diversification Dead?

Diversification (primarily based on asset correlation) is a key component of Modern Portfolio Theory (MPT). However, the recent financial crisis illustrated an increase in correlation across asset categories. Thus, many debate whether diversification still helps. Even with increasing correlations, diversification still provides benefit (possibly just not as much). However, the more relevant issue is that increasing correlation across the typical asset categories suggests that diversification is now more critical across "non-typical" categories -- such as commodities, hedge funds, and private equity funds. See the article here, Journal of Financial Planning.