Morningstar is finally trying to deliver a message about correlation . . . long overdue. This Document was emailed to Individual Investors from Morningstar in August of 2009. However, the message is highly incomplete. This page takes the idea Morningstar is trying to illustrate and reworks it into a practical trading model.

See the Traffic Jam Article below.

The Span and Issues

The asset classes Morningstar chose were not as well defined in 1990 as they are today. Commodities, REITs, and International stocks bore little similarity 30 years ago to the mutual funds covering these sectors today. There were no funds covering commodities and REITS in 1980, and International fund coverage was sparse.

Reworking the list of Classes

Vanguard does a pretty good job building index funds which cover specific classes of investment. In our rework of Morningstar's classes we used Vanguard funds since 1990. We've substituted Vanguard's Energy fund for the Morningstar commodity component. Also, we reduced the bond options to one. All bond funds are all not well correlated to equities and there is no need to have 4 different bond funds in the example. We added the Vanguard's S&P 500 Index fund for a large cap component. Morningstar's' "Traffic Jam" article uses the S&P 500 for the market comparison, so we would assume that an S&P - 500 investment would be appropriate for their discussion.

Risk and Return ( R/R )

First thing to notice in the FastTrack list is risk (SD column) versus return ( Return column). Realty has a very high return while its risk in near the bottom. R/R is supposed to be proportional, and perhaps it is for very long periods. However, for most investors 10-years is a very long period. No one wants to buy into10-years of downside following 10-years of up side. Indeed, after many years of exceptional R / R, realty kicked off a devastating recession worldwide in 2008.

The traditional method of risk control is diversification . . . own a piece of everything. When properly applied, the investor will always experience average risk and average return.

Correlation

Morningstar says, "Investors suffer when correlations merge". In simpler language, a bear market is when what you own goes down. When everything is going down correlations become the same. Therefore, you must shift to non correlated issues regularly to maintain the diversification that protects your portfolio.

FastTrack is not only able to compute correlations like Morningstar, but also provides a simple, nonoptimized trading system that trades a small part of your portfolio at regular intervals typically 30-90 days. the trade days are known in advance and no analysis needs to be done between planned trades.

The 20+ year return of the portfolio managed by FastTrack model (red line) provided a 13.88% gain annually with modest drawdowns, and a SD= 4.01 (Standard Deviation measurement of volatility=risk). The models SD was lower than the unmanaged green and red lines. The green Average return is an equally weighted average of all components rebalancede to equal value monthly. The yello line is the Vanguard S&P 500 fund with dividends reinvested.

Conclusion

Of course, Morningstar is giving advice that has a valid basis. However, they haven't provided a clue about who to use correlation in your own investing strategies . . . "see your financial adviser". That would be good advice if your adviser is a FastTrack user (and thousands are), but many advisers have more training in sales technique than correlation.