Stock-Bond Correlation Reversal Drives Shift to Alternative Investments

The traditional positive correlation between US stocks and bonds has turned negative over the past 20 years, prompting financial advisors to rethink portfolio diversification. Alternative investments, such as ETFs, are gaining popularity as a way to reduce volatility and enhance performance in client portfolios.

Bijay Laxmi
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Stock-Bond Correlation Reversal Drives Shift to Alternative Investments

Stock-Bond Correlation Reversal Drives Shift to Alternative Investments

The traditional relationship between stocks and bonds in the US has undergone a significant shift over the past two decades. Prior to the dot-com crisis, the correlation between these two asset classes was largely positive. However, in the 20 years since, this correlation has turned negative, prompting financial advisors to rethink their approach to portfolio diversification.

Why this matters: This shift has far-reaching implications for individual investors and the broader economy, as it challenges traditional portfolio construction approaches and may lead to increased market volatility. As a result, financial advisors and investors must adapt their strategies to manage risk and achieve their investment goals.

Scott Bishop, managing director at Presidio Wealth Partners, believes that alternative investments are now one of the best ways to achieve true portfolio diversification. "The traditional non-correlation between stock and bond investments is gone, so you get no traditional hedge by holding just traditional stock and bond investments," Bishop explains.

This shift has been driven by a number of factors, including inflation and other macroeconomic forces. Cole Wilcox, chief investment officer at Longboard Asset Management, notes that "Due to inflation and other macro factors, we have seen rising correlations between stock and bond markets around the world, which is reducing portfolio diversification."

The limitations of the traditional 60/40 stock-bond portfolio were particularly evident in 2022, when both asset classes finished the year in negative territory. This has led financial advisors to increasingly turn to alternative investments, such as exchange-traded funds (ETFs), to help reduce volatility and enhance performance in their clients' portfolios.

Several alternative ETFs have demonstrated strong performance in recent months. The VS Trust -1X Short VIX Futures ETF (SVIX) is up 15% this year and 130% over the past 12 months. Similarly, the Volatility Shares -1X Short VIX Mid-Term Futures Strategy ETF (ZIVB) has gained 15% this year and 78% over the past 12 months. Other notable performers include the ProShares Short VIX Short Term Futures ETF (SVXY), the Simplify Interest Rate Hedge ETF (PFIX), and the Convergence Long/Short Equity ETF (CLSE).

The alternatives universe encompasses a wide range of strategies, from shorting market volatility to betting on rising interest rates. As traditional correlations break down, financial advisors are increasingly exploring these creative strategies to enhance performance and manage risk in their clients' portfolios. While the shift towards alternative investments is still in its early stages, it is clear that the changing dynamics between stocks and bonds are forcing a reevaluation of traditional portfolio construction approaches.