Global equity markets have moved into a period of unprecedented correlation that may be masked by strategy labels, which requires some definitive action to avoid, an Australian investment firm has observed.
Talaria co-chief investment officer Chad Padowitz stated that in 1995 about 26 per cent of global invested assets were correlated to the S&P 500, allowing for a strong degree of diversification across the remaining assets, but by this year that correlation was around 90 per cent.
“[Thirty years ago] you had a lot of choices to construct a diversified portfolio, but for a range of reasons that correlation has moved to around 90 per cent, which is quite extraordinary,” Padowitz said during a recent media briefing.
“To be clear, moving on from equities, that correlation included fixed interest, real estate, hedge funds and private assets.”
He said the correlation was not equal across all those asset classes and developed market shares outside the United States were correlated at around 79 per cent, listed property at 82 per cent, hedge funds at 81 per cent and US bonds at 60 per cent.
“There are a few things that have driven that. One is the significant growth of the trillion-dollar tech names that have become the market cap of the market, that is, the S&P 500 is 75 per cent of the MSCI World Index and within the S&P 500 there is a tremendous amount of tech names,” he added.
“So we have that concentration of a few names driving everything, as well as the build-out of artificial intelligence (AI) seeping into other asset classes.
“There is a lot of the data centres coming into the real estate investment trusts and fixed income and private credit is funding a lot of the AI stuff as well.
“The issue we see for most investors is the assumption of diversification via labels and asset classes is not really there and they need to move into different strategies and ways of doing things.”
He said the correlation was likely to continue until confidence in the AI boom waned, but investors seeking diversification could look to real assets and stocks not tied to the current AI and technology wave.
“Real assets are quite valuable and will hold up better and do quite well. They range from precious metals to property, plant and equipment, infrastructure, machinery, manufacturing capabilities – things that are beneficiaries from inflation and would be less susceptible to something that can be replaced with better software,” he noted.
“If you are in some value-driven shares that are not S&P 500 correlated, and you can still find certain companies that aren’t linked to the expectation of an AI-driven growth, but may need more active management, that could be better.”