The Uncorrelated Return Myth

For the last several years, the Holy Grail of asset allocation has been assets that offer "uncorrelated return." The premise is that assets with equity-like risk premiums are, for all intents and purposes, uncorrelated with the broad market. Availing themselves amply of such assets, investors can create high-returning, comparatively low-risk portfolios because they get the average of the risk premiums but the risk itself largely cancels out. A cornerstone of asset-pricing theory is that investors may expect to be compensated for risk they cannot diversify away. Although the capital asset pricing model (CAPM) has been a source of controversy for nearly a half century, it remains the leading theory of asset pricing. More important, however, even though scholars challenge CAPM, rarely do they attack a critical proposition that underlies it: namely, that one cannot expect to get paid for a risk that can be eliminated without cost. This principle is a bedrock of asset-pricing theory.