Last question on the afternoon mock exam: 120. In a strategic asset allocation, assets within a specific asset class are least likely to have: A. low paired correlations. B. high paired correlations. C. low correlations with other asset classes. Answer = A A is correct. In a strategic asset allocation, assets within a specific asset class will have high paired correlations and low correlations with assets in other asset classes. ________________________________________ I thought asset within a speciic class should have low corelation with each other as well… can’t seem to find this info in book. Is the above explantion in the answer make sense ?
I believe asset classes are to have low correlations…but the assets within the asset classes are to have high correlations. This way, when creating a portfolio you know that the securities within an asset class will generally trend in the same direction. At least that how I think it works.
So:
Asset classes - low correlations Assets within class - high correlations
They’re saying that if you are invested in an asset class then you want everything within that asset class to have a high correlation with everything else in it. The point of a strategic asset allocation is to have a broadly diversified portfolio and each asset class should have differing characteristics which help the overall allocation.
An example: if one of your asset classes in a portfolio is small-cap value and you want to have 20 individual stocks that make up that asset class and 19 of them are SCV and one of them now acts more like a mid-cap growth (due to a run-up) then your correlations are now off. You want all of your stocks within the SCV asset class to all act like SCV stocks.