Decreasing Correlation Increases Appeal of Multi-Asset Portfolios

Our current income portfolios: 

DFMAP (Dividend Focused Multi-Asset Portfolio) 
TAC (Treasuries Across the Curve)
VWI (Volatility Weighted Income): We have declared a monthly dividend of 4.23c to be paid 2/28. Note: we only pay dividends as received and February is a seasonally slow month for dividends. 

We have a busy media week ahead: we will be on Schwab Network on Monday 2/26 at 305p to discuss correlation in multi-asset portfolios (topic of our weekly) and on the ETF Prime podcast with Nate Geraci on Tuesday 2/27 to discuss our risk-adjusted portfolio process and VWI. 

Multi-asset portfolios (such as 60/40) are designed to provide investors with market exposure with reduced volatility. When assets are negatively correlated, such as stocks and long-dated government bonds over long periods of time, a portfolio provides superior risk-adjusted returns. The goal is not capturing every last dollar of possible total return but rather risk-adjusted returns.

We discussed the recent correlation trends between SPY (large cap equities) and TLT (long-dated government bonds) two weeks ago and noted the de-correlation YTD in 2024. This trend has continued over the last two weeks with strong interest in AI driving equities higher while the bond market treads water and now pricing in closer to 3 cuts this year. We believe multi-asset portfolios look increasingly attractive in this environment.

Our key points are below:

• Correlation is the key driver of multi-asset portfolios. 2022 was a painful year for multi-asset portfolios because 3m SPY/TLT correlation started at -0.4 and ended the year over 0.3. 

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• Correlation level itself is not as important as change in correlation. 2022 was driven by the rapid change of negative to positive SPY/TLT correlation from Fed tightening. The current environment of decreasing into negative correlation provides a tailwind in volatility reduction.

• The weakness in bonds YTD and back-up in yields provides a better starting point for rotation into income and multi-asset portfolios. Pricing closer to 3 rate cuts this year increases the appeal of owning fixed income if the real economy weakens. 

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• Discussing the frothy equity market is a moot point: there’s little ability of investors to time the market. Investors worried about drawdowns would be better served in a multi-asset portfolio that gives them exposure with less volatility rather than trying to time markets. 

• Multi-asset portfolios come in a variety of flavors and can serve a wide variety of investor needs. 60/40 is the best known portfolio but it is dated and arbitrary in construction. Our VWI Income ETF builds an optimal portfolio of dividend stocks and bonds ETFs weighted by risk-based contribution to maximize income while minimizing volatility. Our process takes advantage of de-correlation among stocks in a sector, between sectors in the market, and stocks/bonds. 

• Correlation is difficult to visualize over time given the large number of combinations: most literature does this at the asset class level. To put in perspective, VWI has 600 available securities which generates over 179,000 2-pair correlation combinations we use in our optimization.

As always your thoughts and feedback are very much appreciated!