Fun with asset allocation.

While I was creating my asset allocation for my passive index investing strategy, I wanted to test the concept of asset correlation. I still need to read a book on asset allocation, but I have been around long enough to know that an ideal portfolio has assets that have a negative correlation. Stocks and bonds are supposed to be like that. And I don’t do bonds for now. So, to satisfy the geek in me, I decided to unleash some math on my trackers in order to understand the correlation. My apologies to the non geeky readers…

As IWDA is the basis of my asset allocation, the correlation is calculated against this tracker. This tracker is around since sept 2009. This is for a die hard staticians not a lot of dat, but for a hobby geek, it is more than enough to have fun.

The world vs Europe experiment

A first series of tests was made with my EU add on trackers. I decided to make a plot of the returns. For that, I take the return of tracker 1 and tracker 2 on day X and plot this out as a point on a graph. I expected to see some strong correlation as one is a subset of the other.

Strong correlation between the world and europe

As you can see in the plot above, there is indeed a positive correlation between the 2 trackers. This is as expected. But is this tracker really the best one I could get.

I decided to to another experiment and compare the one year running correlation of this tracker vs IWDA. I then compared this for another tracker that was on my shortlist.

Comparing 2 trackers vs the IWDA

I was happy to see that the EU tracker I selected has a correlation with IWDA that overtime tends to decline. One can only be happy about this.

What about EM

The ME can not be left out of this serious math. The results make me quite happy.

 The conclusion

There really is no conclusion. This educational experiment is a way for me to find out what the math is behind correlation. It interests me. One can perfectly invest with trackers with bothering about all of this. It helped me a little to decide on what trackers to take for Europe. I can imagine that there are a lot of people out there that will do better than my portfolio, without even knowing the correlation of their trackers.

Remember, the main goal of investing is to reach your own goals, not the goals of someone else. And when investing, make sure that you can sleep at night. It is important to do your own research and set up a portfolio and system that works for your individual situation. Looking at others can be a great source of inspiration, nothing more.