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Stuart Rosenthal Bailey McCann, Opalesque New York

A new risk factor for investors is emerging. Cross-asset correlation is on the uptick according to new research from Factor Advisors. In a report issued last week, the New York-based asset management firm noted that rising correlations among portfolio holdings will decrease diversification benefits and increase overall portfolio volatility.

I spoke with Stuart Rosenthal, Factor Advisors’ CEO, about the findings.

2011 was a rough year for funds. According to the data in the report, correlations are reaching significant historical highs. "Risk on" assets such as small-cap stocks, non-U.S. stocks and emerging stocks follow the moves of large cap stocks closely, which can be difficult for a stock-based portfolio.

The high level of correlation between large cap stocks and smaller cap stocks has pushed investors into other strategies. Bonds, VIX and the U.S. Dollar have emerged as consistent hedge options against a stock-based portfolio.

The report notes that some assets not usually correlated to U.S. stock moves are also experiencing historically significant correlation extremes. "Although gold is sometimes categorized as a "risk off" asset with a flight-to-quality story, its historical correlation with stocks averages zero. Despite several months of strong negative correlation in 2011, gold’s correlation with large-cap U.S. stocks finished the year at +0.23."

All of these factors are combining to create a complex market e......................

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