Regardless of how smoothly they operate, all individuals, organizations, industries, and economies routinely experience setbacks, ranging from minor inconveniences to major catastrophes. Even the most closely managed portfolio is not immune to setbacks. In fact, they are so likely that the best defense may be to expect some losses but to employ a method to help reduce any damage.
Different groups of investments may be subject to different types of risk. Negative correlation is a portfolio strategy that is based on diversification and the assumption that something, somewhere, is bound to go wrong. The idea behind negative correlation is to own asset classes that may offset risks present in other classes.
Perfect negative correlation would mean that when one group of investments in a portfolio performs poorly, another group of assets performs well, offsetting poor returns with good returns.Few asset groups are perfectly negatively correlated, but your portfolio may still be able to benefit from the principle.
A hypothetical example of negative correlation might be the relationship between airlines and rail carriers. Rail carriers may carry more passengers when airlines are facing challenges such as low passenger demand or labor strikes. Likewise, airlines may prosper when rail carriers are facing similar constraints. A hypothetical portfolio that has both airline and rail carrier holdings may be less volatile than a portfolio that owns one type but not both.?
Building an efficient portfolio is a challenge, especially when you consider correlation and other factors.
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