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Must-know: Measuring correlation drift in ETFs

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Correlation drift

Professional managers often observe that during times of market stress (such as in 2008), correlations between asset classes tend to converge. Most asset allocation models are based on certain correlation assumptions between asset classes and securities. We coined the term “ETF correlation drift” as a simple way to track whether correlations between ETFs have changed recently relative to longer-term trends.

We measure ETF correlation drift as the difference between short-term correlation (past-six-month returns) and long-term correlations (past-five-year returns) for any given pair of ETFs.

Recently, U.S. bond ETFs (like AGG, the iShares Barclays Aggregate Bond ETF) have continued to show a higher correlation drift relative to equity ETFs, as shown in the chart above. The chart above shows the correlation drift between AGG and three widely used broad market equity ETFs.

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