Updated: Aug 4, 2021
Image courtesy of xkcd - https://xkcd.com/552/
We recently looked at ETF holdings data and found some interesting insights under the hood (see Digging deepr into ETF holdings and ETF Holdings - Diving in even further.... The holdings data is quite telling in that it can show us how similar 2 different ETFs are in terms of what they hold as well how concentrated some ETFs are versus others.
Equally important, the correlation of returns that different ETFs have with one another can yield further interesting insights that investors may want to be aware of. For holders of ETFs they are likely already interested in ETF benefits like diversification and low-cost fees. If they have a pair of ETFs in their portfolio that have historically performed very similarly (e.g. are correlated), the benefits of diversification may be wiped out because when one ETF does poorly, the other has likely done poorly as well.
This article is not about the pros and cons of lowering the correlation of your portfolio (though there are great links on that - see end of this article). We do, however, look at a variety of interesting correlation pairs that investors may not have known about so strap yourself in and get ready for the chart-fest!
Note: the returns used here are the 1-month price returns reported by ASX and Chi-X which assume dividends are reinvested.
IOZ vs VAS vs A200
These index tracking ETFs are very correlated with one another, unsurprisingly, with correlation co-efficients in the 99% range (basically lock-step movements).
IOZ vs VAS
VAS vs A200
A200 vs IOZ
In this case looking at ETFs from different categories, industries or themes.
In this first example, here's how an ESG (ethical, socially responsible, corporate governance) related ETF like IMPQ is correlated with a technology focused ETF like ASIA.
IMPQ vs ASIA
Comparing it with another ethical/sustainable ETF like ETHI, the correlation increases.
Whilst higher this is still better than holding VAS and IOZ.
Fixed Income ETFs
Looking at Fixed Income ETFs, it's interesting to see an Australian government bond focused ETF correlated (RGB) correlated with an international fixed interest one (VIF)
Not all fixed income ETFs are alike though and some lower correlations exist between XARO and IAF
If you are invested in ETFs and want to look at this sort of analysis, you can do so by going to the ASX or Chi-X to look at the returns they showcase there. You can also run a comparison of different ETFs in the Comparison tool (under Analysis then Comparison) within the ETFtracker app. But, we don't showcase comparisons there yet. Another way is to look at the pure price returns off a free source like Yahoo Finance, however, this does not take into account total returns like the ASX/Chi-X data does. Whichever soure you manage to look at to get the data, you can easily look at correlations using the correl() function in Excel so, if you have the time, you can do the analysis.
Whether you need to reduce the correlations across your portfolio is another question and that is out of the realm of this article. You are better off there talking to a financial adviser or if you are going to do things yourself, as they say on Reddit and Facebook groups, DYOR (do your own research).
On that note, here are some articles on correlation analysis and how it's used in investing:
There are some things to look at in terms of this sort of analysis and the main thing is that it should not be relied upon on its own. So remember the following:
Correlations show movements in similar directions but not magnitude
Correlations are backward looking and do not provide an indication of what will happen in the future - the environment can change and purely using correlations as your guide may not give you what you want
Also, remember the old tenet, "correlation does not imply causation" and for more on that check out Spurrious Correlations for some even more amazing charts than what's above.
Happy investing folks!