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You've probably heard the advice a hundred times. Stocks for growth. Bonds for safety. Mix them together, don't panic and let time do the heavy lifting.

And for most of the last four decades, this approach actually worked. The secret wasn't some magic asset allocation formula.

It was something much less exciting sounding: ✨correlation✨

First things first, what even is correlation?

Correlation is how two things move in relation to each other. It sits on a scale from -1 to +1.

• A positive correlation means two things tend to move in the same direction. Think petrol prices and transport costs. One goes up, the other usually follows.
• A negative correlation means when one goes up, the other tends to go down. Think umbrella sales and sunshine.
• A correlation of zero means the two things move independently, with no predictable relationship.

In investing, negative correlation is the holy grail. The idea is that if you own assets that work in opposite directions, your portfolio is more likely to deliver a smooth return profile… you don't get the full gut-punch when markets crash, but by the same token total portfolio returns are somewhat muted when markets go on a tear.

What's actually positively and negatively correlated - and why it matters

Here's a rough cheat sheet of how major asset classes have historically tended to move relative to each other:

Of course, correlations aren't fixed. They shift depending on what's driving markets.

With all different assets moving in different directions, building a genuinely diversified portfolio is complicated. You need to understand different asset classes, why they correlate, when that correlation tends to break down and how to rebalance dynamically.

That’s enough to make anyone's head spin before the market even opens.

The shortcut: outsource it

If actively managing correlation sounds like a lot of work, there's a simpler path: invest in a fund that does it for you.

Diversified portfolio ETFs are built specifically to hold a mix of assets with different correlation profiles. And that’s not just stocks and bonds, but a broader mix of:

• Stocks
• Bonds
• Cash
• Alternatives
• Infrastructure
• Real assets

It's creating a portfolio where different components can perform different roles when economic conditions change.

The Schroder Real Return Active ETF (ASX: GROW), managed by Schroders Australia is built around the Total Portfolio mindset. The goal is to target returns of inflation plus 4-5% before fees over a rolling three-year period, while also minimising the frequency and size of negative returns. Worth noting: the return target isn't guaranteed, all investments carry risk, and the value of your investment can go down as well as up.

This article was produced in partnership with Schroders. Before making any investment decision, you should consider seeking independent professional advice and read the relevant Product Disclosure Statement at schroders.com.au.

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