Rethinking Portfolio Diversification: Why Relative Volatility Outweighs Correlation
Reducing portfolio volatility is a primary goal for insurers, often pursued by diversifying into corporate bonds, private credit, infrastructure, and real estate. However, these assets frequently embed equity risk, exacerbating portfolio volatility during market crises.
Dr Laura Ryan’s research challenges the traditional reliance on correlation for diversification, emphasising that relative volatility and volatility predictability are more critical metrics for effective risk reduction. Assets with lower volatility relative to the portfolio consistently deliver stronger diversification benefits, regardless of their correlation with other assets. Moreover, predictable volatility minimises drawdowns, shortens recovery times, and mitigates tail risks, thereby enhancing portfolio resilience.
Her findings highlight that many alternative assets fail to provide meaningful diversification due to shared risk factors with equities. By prioritising relative volatility and stable risk characteristics, insurers can achieve more robust and consistent volatility reduction, offering a practical framework for constructing resilient portfolios in turbulent markets.
Authors of the research
Dr Laura Ryan, PhD, Head of Research Ardea Investment Management, Adjunct Ass. Professor UTS
Patrick Matthews, Quantitative Engineer
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