Seeking low correlation

It is almost impossible to talk about diversification without quoting Nobel Prize-winning economist Harry Markowitz, who famously said “diversification is the only free lunch in investing”. The reason why diversification is so important to Markowitz and every other investor is because it offers the ability to reduce a portfolio’s risk without compromising the potential for returns.

On a broad asset allocation level, bonds are the most obvious way of diversifying equity exposure thanks to the fact that government bonds have historically had an inverse relationship with the stockmarket. Alternative assets such as property, gold and absolute return strategies are other common ways of diversifying a portfolio.

However, diversification is also important within asset classes. Holding a large collection of stocks that go up at the same time only to fall together is not the best way to approach portfolio construction, so many investors aim to own equities which will not move in lockstep.

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This is especially important when investors build their portfolios around a core of domestic stocks: in order to achieve the best diversification, investors should ensure that some of their other equity positions have a low correlation to their dominant Australian shares exposure.

To this end, Money Management used FE Analytics data to determine how correlated the ASX 200 has been to more than 100 other indices, including individual countries, geographical regions, investment styles and market capitalisation, over the past five years. Of course, it must be kept in mind that past performance is not a guide to the future.

The results of this research can be seen in Table 1. Five indices have an inverse correlation to the Australian stockmarket: those for Trinidad and Tobago, Jordan, Bosnia and Herzegovina, and Tunisia.

However, these are very small markets – each of the above MSCI indices has just two constituents, making them unlikely candidates for investors seeking to diverse away from their dominant Australian equity allocation.

Table 1: Equity indices with the lowest correlation to the ASX 200


Things look more promising when we get to the sixth least-correlated index to the ASX 200: MSCI China. The Chinese economy is the second-largest in the world and an increasingly important player on the global stage, putting it firmly on the radar of most investors.

The MSCI China index has had a correlation of just 0.02 to the Australian stockmarket. However, it has made less than the ASX 200’s 55.4% total return, gaining just 20.7% in Australian dollar terms in the five years to the end of March 2022.

The index offers much broader investment set than the smaller markets highlighted above: there are 738 constituents in the MSCI China index, covering about 85% of the Chinese large- and mid-cap equity universe. 

Large companies found in the index include technology and entertainment conglomerate Tencent, e-commerce giant Alibaba and financial services group Ping An Insurance, which should be familiar names to many investors.

Of the Chinese equity funds available to Australian investors, the lowest correlation to the ASX 200 came from Jing Ning’s Fidelity China fund – it’s five-year correlation is just 0.02. The fund has a long-track record, having launched in 2005, and has made almost an identical return to the Australian market over the past decade, although it is underperforming the ASX 200 over shorter time frames.

Other China funds with a low five-year correlation to Australia include Vasco ChinaAMC China Opportunities (0.03), Premium China (0.14) and VanEck FTSE China A50 ETF (0.16).

While Chinese equities have underperformed the home market in recent years, not every region with a low correlation to Australia is lagging behind it.


Our research also suggests that the Middle East could be a source of investment opportunities for those looking to diversify. While many of the individual countries in the region have a limited number of stocks in their indices, the MSCI Arabian Markets index presents a larger opportunity set with 85 constituents.

Its five-year correlation to the ASX 200 is just 0.37 and it has made a far higher total return at 113.6%, largely down to its very strong performance over the past year or so. 

Some of the biggest members of the index are Saudi Arabia’s Al Rajhi Bank, United Arab Emirates telecommunications firm Etisalat and Qatar National Bank; around 60% of the index is in financials, with 15% in materials and 11% in communication names.

Other countries that have outperformed Australia while holding a relatively low correlation include Denmark (up 124% with a correlation of 0.33), Vietnam (up 88.5% with a correlation of 0.43) and India (up 71.8% with a correlation of 0.54).


When it comes to global equity sectors, the lowest correlation came from consumer staples companies. The MSCI AC World Consumer Staples index has a correlation of 0.21 to the ASX 200 while posting a 40.2% total return over five years.

Consumer staples firms produce essential products that people are unable or unwilling to stop buying regardless of their financial situation – goods like food and beverages, hygiene products, household goods, alcohol and tobacco. 

Because their products are always in demand, consumer staples businesses tend to display steady growth and are especially resilient in recessionary times, becoming something of a safe haven for investors.

Among the companies in the MSCI AC World Consumer Staples index are big names such as Proctor & Gamble, Nestlé, Coca Cola, Walmart, Philip Morris, Unilever and L’Oreal.

Global telecommunications stocks are another potential diversifier with a low correlation of 0.27 to the Australian market, as is healthcare with a 0.32 correlation. Like consumer staples, both sectors are seen to have defensive characteristics and are used by investors to improve the resilience of equity portfolios in times of market stress.

Among the investment styles, the past five years have seen the Australian equity market have the strongest correlation to value stocks (0.68), which is not too surprising given the heavy weighting to cyclical sectors like financials and materials. But the correlation to growth stocks – from sectors like information technology – is not far behind at 0.60. 

Global quality stocks potentially offer the most diversification benefit with a correlation of 0.54 to the Australian market, which is interesting at the moment as many see these as a good way to protect portfolios against the impact of soaring inflation and rising interest rates. Stocks such as Apple,

Microsoft, Meta, Taiwan Semiconductor Manufacturing and Visa are counted among the largest constituents of the MSCI ACWI Quality index.

And on market capitalisation, global large-caps have the lowest correlation to the ASX 200, although this is still quite high (0.68). For global small-caps and mid-caps, the correlations are 0.80 and 0.78 respectively.


In order to diversify their equity exposure away from Australian stocks, many investors’ first port of call will be a global equity fund. Our research shows that the correlation here is still on the high side – the average fund in FE fundinfo’s ACS Equity Global sector has a 0.74 correlation with the ASX 200, which is higher than the index’s correlation to the MSCI World (0.69).

Of the 194 global equity funds with a long enough track record, just 14 have a correlation of less than 0.45 to the Australian market. They can be seen in Table 2 along with their returns over the five years in question.

The lowest correlation came from Fidante Credit Suisse Global Private Equity, which has had an inverse relationship with the Australian market. However, this inverse correlation is down to the fact that the fund has lost almost 30% over five years, while the ASX 200 has been rising.

But several of the funds on that list have beaten the Australian market over this period, with the strongest returns coming from CFS FC Baillie Gifford W LT Global Growth (up 138.2%) and Loftus Peak Global Disruption (up 144%). Even the under-fire Magellan Global fund is ahead of the ASX 200 by more than 10 percentage points over this period.

Table 2 Global equity funds with the lowest correlation to the ASX 200

Source: Fe Analytics

It’s worth pointing out that all of the funds on table have lagged far behind Australian shares over the past three months, when the global market has been panicked by rising inflation, interest rate hikes and the war between Russia and Ukraine but the domestic stock market has managed to make a positive return.

Some of the strongest funds over five years have been hit hardest in 2022’s first quarter, with CFS FC Baillie Gifford W LT Global Growth down 24% and Loftus Peak Global Disruption losing 14.5%.

But investors seeking diversification in the ACS Equity Global sector are not limited to the 14 funds on the table. A ‘strong’ correlation is anything above 0.70, but there are 142 funds in the global peer group with a correlation below this and therefore the potential to offer diversification away from the home market.

Among these are some of the bigger names in the sector, including Vanguard International Share Index (0.68 correlation to the ASX 200), Macquarie IFP Global Franchise (0.50 correlation), MFS Concentrated Global Equity Trust (0.50 correlation), VanEck MSCI World ex Australia Quality ETF (0.51 correlation) and Hyperion Global Growth Companies (0.56 correlation). 

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