The Future of Diversification: How Rising Stock Correlations Are Changing Investing

Introduction

Diversification has long been a cornerstone of sound investing. The idea is simple: don’t put all your eggs in one basket. By spreading investments across various asset classes and regions, investors can reduce risk and smooth out returns over time. But what happens when those baskets start moving in the same direction?

In today’s globalized economy, rising correlations among stocks and other asset classes are challenging the traditional approach to diversification. As market forces become more synchronized, investors are finding that broad asset exposure no longer provides the downside protection it once did. At SciVest, we view this shift through the lens of our Core Investment Beliefs, particularly diversification, strategic asset allocation, and disciplined risk management.

The Historical Role of Diversification

Diversification was formalized in the 1950s by Harry Markowitz through Modern Portfolio Theory (MPT), which demonstrated that portfolio risk could be minimized by combining uncorrelated assets. For decades, this approach worked: equities and fixed income often moved in opposite directions, and combining developed and emerging markets, or different sectors, added an additional layer of protection.

• Equities vs. Bonds: Traditionally, when stocks fell, bonds rose as they are generally seen as safer investments during periods of market stress. Thus, bonds provided a natural hedge and helped to stabilize portfolio returns.
• Geographic Diversification: Adding emerging markets reduced exposure to Western economic cycles and increased exposure to different growth drivers. For instance, emerging markets boomed in the 2000–2010 decade, even as some developed markets languished, rewarding those who held a mix.
• Sector Diversification: Further, ensuring that weakness in one sector, like tech, doesn’t derail the entire portfolio, helped stabilize portfolios as sectors such as energy or healthcare often respond differently to economic conditions. The rule of thumb was clear: the more uncorrelated your assets, the better your protection.

The Correlation Conundrum: What’s Changing?

Over the past decade, especially during crises like COVID-19, we've seen increasing correlations between global equities and even between equities and bonds. Several factors are driving this trend:

• Central Bank Policies: Since the 2008 financial crisis and again during COVID-19, central banks globally cut interest rates and used quantitative easing to support markets, lifting both stocks and bonds. But when central banks tighten policy, as they did in 2022, both stocks and bonds can fall at the same time. As noted by Intech Investments, these interventions have shifted asset class correlations, making it harder to rely on bonds as a safe haven during global policy shifts. What used to be a reliable negative stock-bond correlation can flip positive in certain regimes, making it harder to find a safe haven asset during worldwide policy shifts.
• Globalization:Interconnected supply chains and shared economic risks have led to more synchronized market movements. Since the late 20th century, studies have shown a “marked increase in correlation between the global equity markets”. For example, after the formation of the European Union and the adoption of a single currency, European stock markets began moving more closely together. Similarly, emerging markets became increasingly linked to U.S. and UK markets in the 2000s as they opened up and attracted international investment.
• Technology and Information Flow: Modern markets are also influenced by lightning-fast information flow and algorithmic trading. When news breaks, it is rapidly interpreted in a similar way by traders and algorithms across markets, often leading to simultaneous buying or selling. This can increase short-term correlations among assets. Intech notes that the rise of electronic and quantitative trading can cause assets to become more correlated, as many strategies respond uniformly to the same signals (intechinvestments.com).
  
  

What used to be diverse now often moves in lockstep especially during market turmoil as seen above. The traditional safety of spreading assets across regions or asset classes has become less reliable.

Why It Matters: Risks of Higher Correlations

The implications for investors are significant:

• False Sense of Security: Holding many stocks or funds may seem safe, but if they’re highly correlated, the portfolio behaves like a single, concentrated position. For example, owning an S&P 500 fund, an international equity fund, and a tech fund may feel diverse, but in a downturn, they can all fall together. As Markowitz warned, “100 securities moving in unison offer little more protection than one. (locorrfunds.com) 
• Volatility Spikes: Rising correlations increase portfolio volatility and weaken the benefits of diversification. When most assets move together, portfolios experience sharper swings, even if they appear broadly diversified. This was evident in March 2020 and again in 2022, when the traditional 60/40 portfolio, long considered to be a relatively safe mix, suffered steep losses as both stocks and bonds fell together, removing the usual safety net.
• Drawdowns During Crises: During downturns, the lack of uncorrelated assets can lead to deeper drawdowns and underperformance, especially when diversification is most needed. Concentration risk adds to this problem, if a few dominant stocks drive returns, a portfolio may be more vulnerable than it appears. In fact, Canadian investors saw this in 2022–2023: U.S. equity indexes were heavily skewed to a few tech giants, so a “diversified” index holding wasn’t as diversified as it seemed (investmentexecutive.com).  

When everything drops together, diversification fails to cushion the blow. Rethinking portfolio construction becomes critical as correlation rises.

Modernizing Diversification: What Can Investors Do?

To adapt, investors must look beyond traditional asset classes and embrace a more robust definition of diversification:

• Alternative Assets: Real estate, infrastructure, commodities, private equity, and hedge funds often react differently than public equities. For example, commodities may perform well during inflation when stocks struggle. Private equity and venture capital offer access to growth beyond daily market swings, while hedge funds and managed futures aim to generate returns that don’t rely on market direction. Even a small allocation to alternatives like gold, which has low correlation to equities, can improve long-term portfolio resilience
• Factor-Based Investing: Not all stocks behave the same, factor investing helps capture those differences by tilting portfolios toward traits like value, quality, momentum, or low volatility. These factors perform differently across market cycles, when growth stocks lag, value or low-volatility stocks may do better. Using factor-based ETFs or equal-weighted index funds can offer more balanced exposure and reduce dependence on a few large companies, like the Magnificent 7. This approach adds diversification within equities by creating multiple sources of return.
• Geographic Rotation: While global markets are more connected than ever, regional differences in performance still occur. Diversifying beyond your home market helps capture opportunities when other regions, like Europe, Developed Asia Pacific, or emerging markets, take the lead. Market leadership shifts over time, and a strategically globally diversified equity allocation ensures you're not overly exposed to one economy’s fate. 

By seeking true diversification through alternative assets, factors, and global opportunities, and by staying vigilant to correlation shifts, investors can modernize their portfolios for the current era.

The Role of Strategic Asset Allocation

Diversification alone isn’t enough. Asset allocation, the mix of stocks, bonds, and alternatives, must align with your goals, risk tolerance, and time horizon. Key practices include:

• Rebalancing: Rebalancing is the process of selling some of what’s gone up and/or buying more of what’s gone down to bring the portfolio back to its target weights. It’s a disciplined, rules-based way to “buy low, sell high” and maintain your intended risk level. SciVest emphasizes this by providing ongoing portfolio management in our clients’ Separately Managed Accounts – we continuously trade and adjust holdings to adhere to the strategic allocation, so clients “set it and forget it” while we do the maintenance.
  
  
• Avoiding Market Timing: Strategic allocation and rebalancing work best when you adhere to them consistently, especially in turbulent times. The alternative – trying to time markets or make big allocation changes based on gut feelings or short-term predictions usually backfires. Emotional investing often leads to buying high (greed during rallies) and selling low (panic during crashes), which is the opposite of what one should do – a tough but ultimately rewarding move as markets recover. A strategic approach helps take the emotion out of investing, as SciVest believes an unemotional, evidence-based process leads to better outcomes.
  
  
• Long-Term Focus: While strategic allocation is about long-term targets, it can still incorporate flexibility. Think of it as having a core plan with some room for tactical tilts when opportunities or risks emerge. For instance, if valuations in one asset class become extreme, a modest underweight or overweight relative to the strategic target might be warranted. The key is that these are usually incremental adjustments, not all-in/all-out calls.SciVest’s core belief in strategic allocation means we focus on getting the big picture (your asset mix) right, rather than chasing hot sectors or trying to time exits and entries. Let compounding and strategy drive returns, not short-term noise.

These approaches reflect SciVest’s beliefs in strategic asset allocation, cost control, and long-term, rational investing.

Conclusion

In essence, the future of diversification will likely involve a more multifaceted, thoughtful approach to portfolio construction, combining old wisdom with new tools. At SciVest, this philosophy is already ingrained: use strategic asset allocation to set the course, use intelligent diversification (including alternatives and factors) to build resilience, and use cost-efficient, evidence-based methods to execute the plan.

We are passionate about keeping investment costs low for clients (as one of the lowest-fee providers in Canada) because high costs can eat away the benefits of diversification. You might have the perfect all-weather portfolio, but if you pay hefty fund fees, your net returns suffer. That’s why SciVest asset allocation portfolios often use low-cost index ETFs to gain broad exposure and “democratize institutional-quality portfolio management for regular Canadians at the lowest price”. We remain confident that this approach gives investors the best chance of navigating whatever the markets throw at us in the years ahead.

The investing landscape is always changing – correlations rise and fall, economies evolve – but a well-diversified and well-managed portfolio is as crucial as ever. By staying diversified, adaptive, and disciplined, and by keeping a long-term perspective, investors can continue to thrive even in a world where the baskets (assets) occasionally all move together. The key is to fill your basket with not just more eggs, but different eggs. That is the future of diversification.