Higher correlation in price movements between different assets is making it more difficult to diversify investment risk and could result in ...

Higher correlation in price movements between different assets is making it more difficult to diversify investment risk and could result in wide-ranging losses if and when economic conditions worsen, according to the UK’s financial regulator, the Financial Services Authority. Some nominally diversified portfolios were considerably more risky than investors realised, says the FSA in the regulator’s annual Financial Risk Outlook report. The FSA has specific concerns about new correlations between equities and commodities, commercial property, and some fixed-income products. According to the Risk Outlook report: “The combination of low volatility, high correlation and a historically low level of risk brings with it an inherently high likelihood of a major shock, especially if an event were to occur that triggered a significant deterioration in market sentiment.” The FSA cannot say whether increasing correlations reflected a structural shift in markets or are temporary.