Criteria for asset class

CFA Level III
#1

  • Homogeneous (Within asset class)

  • Mutually exclusive

  • Diversifying asset classes

  • Majority of world investable wealth

  • Liquidity

If the test give us the very low correlation number between two asset class, it should be the reason belong to diversifying asset class or mutually exlusive? Or both?

#2

I don’t know if I understand your question perfectly, but correlation doesn’t have to be low for asset classes to be considered diversifying E.g. US Large Cap Value and US Small Cap Value I think the correlation is (0.85 - 0.90)

Mutually exclusive means that I can’t list US Equities and US Small Cap Growth as two distinct asset classes because US Equities includes US Small Cap Growth. The securities/assets need to “fit” into only one asset class. No overlap.

#3

Thanks, then what’s diversifying asset classes mean…

#4

According to the text, any pairwise correlation greater than 0.95 would indicate that the asset classes are not diversifying and you would effectively duplicate risk exposures.

US Mid Caps and US Large Caps generally run pretty high correlations which is why you see a lot of portfolios that omit Mid Caps and just have Large and Small caps.