Correlation Matrix of all our VTS Strategies

Jan 22, 2024


VTS Community,

In my opinion correlation is one of the most criminally underrated statistics in the investment world.  You'll rarely hear anyone talking about it in any detail.  On the flip side, it's very common to hear people talking about the importance of having a diversified portfolio.  That's a buzzword you'll hear everywhere.  Diversification, investors need diversification etc...

There's a problem though.  A true measure of diversification can't be done without serious analysis of correlation.  It's one of the primary methods of determining whether two assets or strategies do actually move differently to one another.

Here's the Correlation Matrix of our VTS strategies:

Some of you will know what that chart means and how to use it, but for those that aren't familiar, let's break it down a little.

The biggest thing you have to remember with respect to correlation is that it only refers to direction.  It does NOT measure any magnitude.


Correlation ranges from -100% to +100%, but you may sometimes hear it discussed on a scale of -1 to +1.  At VTS I always use percentages so if you focus on that it'll be consistent with my articles and videos.

-  A correlation of 100% or 1 means the two securities or strategies always move in the same direction.

* Again, this does not imply magnitude so it doesn't mean both securities or strategies move the same amount.  It only says they both move in the same direction.

When one goes up, the other one always goes up.  When one goes down, the other always goes down.


-  A correlation of -100% or -1 means the two securities or strategies always move in the opposite direction.

When one goes up, the other one always goes down.  When one goes down, the other one always goes up.


-  A correlation of 0% implies no correlation at all


In the real world of live trading...

- Strong positive correlation is a dime a dozen.  In fact, many securities and asset classes show correlation to the S&P 500 of 90% or more meaning they nearly always move in the same direction. 

This applies to strategies as well.  The vast majority of them when you look at how they move day to day are essentially just different leverage factors of the stock market.  When stocks go up, so does the strategy.  When stocks crash, the strategy suffers the same fate.  Not overly helpful because if someone wanted to be highly correlated to the stock market, they should just own the stock market and keep things simple right?

- Strong negative correlation however is very rare.  In order to get that you'd essentially have to be short the market most of the time.  Given that there is a very pronounced positive skew to equity performance over longer periods of time, it's investing suicide to carry constant short positions.

When it comes to strategies, what we're looking for in a perfect world would be correlations of around -10% to +60%.  A suite of strategies in that range would be very beneficial, which is what my work at VTS is all about.


What is a diversified portfolio?

If an investor is building a portfolio with multiple assets or strategies, it's not nearly enough that they "sound" different.  We actually have to go through the exercise of calculating just how different they are.

For example, stocks and real estate sound like different asset classes.  Stocks and Hedge Funds certainly sound different.  But if the mathematical correlations are 90% or higher, then are they really diversified?  If both always move in the same direction, what benefit is there to holding both?

Again, -10% to +60% is the sweet spot of being able to benefit the portfolio in a bull market when stocks are doing well, and being low enough to add real diversification to the overall package.


How to use the chart?

All you do is follow the rows and columns of any two of the strategies shown and the intersection point is the correlation between them.

For example, the correlation between the Defensive Rotation Strategy and the Strategic Tail Risk Strategy is 26%  (shown in the chart below)

This is very low meaning that these strategies very often move in different directions.  Since both have a strong positive rate of return, yet show low correlation to one another, it means it adds real diversification to trading both at the same time.

Points of interest


1)  The VTS Total Portfolio Solution and the S&P 500 only have a correlation of 50%.  If you're not overly familiar with investing results this may not mean much to you but I assure you this is extremely low.

As a point of reference, the universe of "Hedge Funds" comprises many different strategies, market biases, and assets traded.  Yet the HFRI Composite Hedge Fund Index has a correlation to the S&P 500 of over 90%.  Trust me, getting it down to 50% and still returning over 20% in a bull market is EXTREMELY difficult, dare I say unheard of.

I've said it many times before but I'll say it again.  Of all the performance statistics we can look at, my low correlation to the stock market is the one I'm most proud of. 


2)  From a pure rate of return perspective our Iron Condor Strategy is our lowest performer at around 17% Annualized since January 2012.  However, the reason it's such a vital part of the overall portfolio is that it has the lowest correlations to the S&P 500 and all the other strategies we trade than anything else.  You can see it's single digits or negative across the board. 

Given this, I truly believe that regardless of whatever is in their portfolio, everyone would benefit greatly from adding the VTS Iron Condor strategy


3)  Among our three tactical ETF strategies  (Defensive, Volatility, Strategic)  our Tactical Volatility Strategy has the lowest correlation to the S&P 500 at just 35%.  Now Strategic Tail Risk isn't far behind at 36%, but these numbers are very low.

As I mentioned above, low correlation is less difficult to achieve if you're just taking short stock market positions.  Stocks go up most of the time, so the simplest way to reduce correlation is to short stocks...

However, getting correlations down to 35% while also greatly outperforming the stock market in a bull market is a feat in itself.  Sorry if that sounds arrogant but facts are facts.


Ignore correlations at your own peril

This criminally underrated statistic should get a lot more love in the investment world than it does.  I suspect the main reason for the absence is simply that most asset managers don't want to draw any attention to the fact that their correlation to the S&P 500 is well over 90%.

It's pretty tough for them to talk about diversification, and then have a mathematical calculation that proves they are not diversified.  That definitely blows a giant hole in the marketing campaign so they just ignore it and hope nobody notices.

I don't suggest you do the same though.  Having a lower correlation to the stock market portfolio wide will be very valuable the next time the stock market has a 30, 40, or 60% crash.  When that happens  (and it will)  people will wish they paid more attention to correlation.

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