Correlation

Definition

Correlation describes the degree to which returns of two assets or strategies move together over time. Low or negative correlation can improve diversification and reduce portfolio volatility, while high correlation increases concentration of risk even when holdings appear different. Correlation is not stable; it can change across regimes and often rises during stress events. Allocator Context Allocators use correlation to evaluate whether a strategy provides true diversification or simply repackages existing beta. Correlation analysis is used alongside factor exposures, scenario analysis, and stress testing. For illiquid strategies, correlation is harder to measure due to valuation lag, so allocators rely on proxy factors, deal characteristics, and stress assumptions. Decision Authority Correlation insights influence portfolio construction, sleeve sizing, and risk budgets, and may be cited in committee discussions when approving new strategies or increasing exposure. High correlation to existing exposures often limits allocation size. Why It Matters for Fundraising Managers should be careful with correlation claims. The most credible approach is explaining what drives returns and how the strategy behaves in specific environments, rather than asserting “low correlation” without context. Allocators reward managers who can show realistic diversification contribution and acknowledge regime risk. Key Takeaways Correlation drives true diversification Correlation can change in stress regimes Illiquid correlation is hard to measure directly Fundraising improves with defensible behavior explanations