Want to learn something about correlation, also known as correlation coefficient? Conceptually, correlation appears simple and recognizable. When two asset classes trade simultaneously in the same direction, they are in positive correlation. When two asset classes trade simultaneously in opposite directions, they are in negative correlation.

Correlations between asset classes differ constantly. Somewhat like a marriage. You go to bed, and synchronicity is positive (what I’ll call positive correlation). In the morning you wake up asking what happened! You both simultaneously disagree on everything (What I’ll call negative correlation.)

During 2007 and 2008, the U.S. $ suffers burdens against nearly every currency. At the same time, oil costs per barrel increase (Important to point out that the cost-per-barrel is dollar denominated.). When looking at a chart, you will notice that when oil goes up the dollar goes down. When the dollar goes up, the price-per-barrel goes down. We call this negative correlation; in fact, just about perfect negative correlation and this explains the trades back and forth between the dollar and oil.

Your asset allocation model wants as many cross correlated asset classes as possible. When one is up, the other is down.

Some school endowments willingly take risks others avoid, and the results prove that sticking your neck out “pays-off”, according to the Business section of the (click here to read the article) Boston Globe (November 2, 2007) Globe staff write Robert Weisman lists “buyout, venture capital, and hedge funds” as the dominant alternative asset classes. School endowments allocating to these broader asset classes out-performed other school endowments and corporate pension plans consistently.

Better endowment performance comes from the larger and better ivy league schools (such as Harvard, Yale, Brown, Columbia, Cornell, Dartmouth, and Princeton). Better schools have larger endowments. Elite schools hire smarter managers, smarter staffs, and wiser directors. Smarter endowment fund managers recognize and balance risk/reward strategies that include alternative asset classes.

Identifying opportunity early gave leading endowment funds a front-row seat in the alternative asset class arena. Others wanting similar results mimic, but smaller players lack the confluence of resources that gain the recognition accrued by the elite colleges, or they lack the courage, or they’re sitting too far from the front row in the arena of alternative asset classes.

Then there’s the other maddening unpredictability of any asset classes results going forward. “…it’s not clear the investment philosophy these guys had will be as well-suited,” Lerner said, “to the period going forward.”

Identifying a wide range of asset classes as an individual takes work. Typical asset allocation models exclude alternative asset classes such as water, alternative energy, and lumber. For large endowments, risk is not a bad word.

Just the same, don’t rush to find your seat in the investment alternative arena. Dr Lerner said, “To conclude that more investments in alternatives will lead to higher returns is simplistic…There are a considerable number of omitted variables that we are not measuring here, which may be impacting the results.”

Alexander Pope wrote, “Fools rush in where angels dare to tread.” (No; Jonny Mercer did not come up with that phrase; Pope did when writing (“An Essay on Criticism”).

Asset allocation prevents foolish acts.