Chart of the Month – Portfolio Construction and Negative Correlation

by Alexis Sautereau

Portfolio Construction and Negative Correlation, from the Strategy HF uncorrelated perspective.

Source: NS Partners

The concept of negative correlation is a key one in portfolio construction.

Negative correlation between x,y,z, criteria enables the creation of diversified portfolios that can better withstand market volatility and smooth out portfolio returns over the long term. The building of hedge fund portfolios where the correlations are carefully balanced to provide more predictable volatility is a necessary discipline in that respect.

Therefore, this evaluation and comparative process is an important part of the Strategy HF Uncorrelated investment process.

This evaluation can take place from 2 main vectors. One is ex-post and tends to rely on historical data (track record), the other would be considered as ex-ante and relies on the identification of the funds trading style and risk profile. So, when sufficient track-record is available it can be used as the first level of analysis to identify the correlation profile of a fund vs. its peers, and other positions within the Strategy HF Uncorrelated portfolio, so to minimize the risk of convergence in specific market situations. When there are not enough data to validate the quantitative approach, understanding the fund risk profile and trading style when deploying its strategy can be a strong indicator of forward correlation to many designated markers we decide to track to maintain the Strategy HF Uncorrelated overall risk-return profile.

The first table provides an instant view of the underlying funds relations from a correlation point of view. The more negative correlation shows up the better and the more robustness can be expected. In our view, for a fund of funds like the Strategy HF Uncorrelated it is preferable to maintain the majority of correlations below 0.50 so to maintain the integrity of the risk-return profile of the portfolio. The more negative correlations show up… the even better, but not an easy task.

The second graph is a representation of the diversity of risk return profiles we hold in the portfolio and where the portfolio itself stands. It provides a visual perception of the dispersion of risk profiles of underlying funds, and the outcome of the aggregate when looking where the Portfolio seats.

These two graphs are available on a monthly basis in the Strategy HF Uncorrelated reporting.






Past performance is not indicative of future results. The views, strategies and financial instruments described in this document may not be suitable for all investors. Opinions expressed are current opinions as of date(s) appearing in this material only.

References to market or composite indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only. NS Partners provides no warranty and makes no representation of any kind whatsoever regarding the accuracy and completeness of any data, including financial market data, quotes, research notes or other financial instrument referred to in this document.

This document does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorized or to any person to whom it would be unlawful to make such offer or solicitation. Any reference in this document to specific securities and issuers are for illustrative purposes only, and should not be interpreted as recommendations to purchase or sell those securities. References in this document to investment funds that have not been registered with the FINMA cannot be distributed in or from Switzerland except to certain categories of eligible investors. Some of the entities of the NS Partners Group or its clients may hold a position in the financial instruments of any issuer discussed herein, or act as advisor to any such issuer.

 Additional information is available on request.

© NS Partners Group

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