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Net Net: Promoting innovation and managing change

The next big investor challenge: Correlation

Traders work on the floor of the New York Stock Exchange on the afternoon of March 4, 2014.
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The turmoil around the globe currently haunting the markets has raised another nasty specter: The days of widely correlated assets that make portfolio diversification a massive headache.

Though not at financial crisis levels, the tendency of the asset classes to move up or down together has increased substantially during the equally seesawing market of 2014. Correlation among the 10 sectors is now at 85 percent, according to ConvergEx, after registering numbers around half that level in 2013.

Nick Colas, the chief market strategist at ConvergEx, thinks it's a good sign that correlations haven't reached the record 95 percent levels seen during the peak of the euro zone debt crisis in 2011.

But it's still well above the days of 50 percent that had long been considered the market norm, and indicate that a return to the "risk-on risk-off" crisis mentality is just one more global headache away.

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"The average sector correlation for the 10 industries represented in the S&P 500 was 85.1 percent over the last month. Now, you might say that is high, and by historical measures you'd be right," Colas said in a note. "Still, the average correlation for tech, healthcare, industrials and other sectors versus the S&P 500 Index was 95 percent in late 2011. By that measure we're making progress."

But where to go for investments that zig when the rest of the market zags?

Utilities have just a 55 percent correlation to the rest of their cohorts in the S&P 500. Telecom stocks are moving in unison 73 percent of the time, and energy has the third-lowest correlation rate, all the way up at 81 percent. Conversely, industrials are in near-perfect lockstep at 95 percent.

For really strong diversification, then, investors often look beyond stocks to other investments.

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Investment-grade bonds, for instance, have just a 31 percent correlation to stocks, much better than junk bonds, which are at 85 percent. (Remember, correlation is like golf when it comes to diversification: The lower the score the better.)

The best diversification tool for the year has been precious metals. Gold and silver have a minus-15 percent correlation to stocks, while posting respective gains of 14 percent and 8.5 percent, according to ConvergEx.

There are other choices—alternatives, actually, as in alternative funds like long-short exchange-traded funds that offer a mix of plays on stocks going up or down.

"I've really tried to build a portfolio that outperforms on the downside and I get 60-to-70 percent on the upside," said Keith Springer, president of Springer Financial Advisory in Sacramento, Calif. "I think it's suicide when you're looking at solely upside."

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There also are opportunities in currencies.

The Japanese yen, for instance, has traditionally been a strongly noncorrelated asset and is at minus-74 percent now. The Australian dollar has a 42 percent correlation and the euro is at 10.5 percent.

For retail investors, finding those alternative choices—and the proper investment vehicles to use—can be tough.

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That's why Nadav Baum, executive vice president at BPU Investment Management in Pittsburgh, believes most investors are better off focusing on owning great companies and using sector diversification rather than alternative investments.

"I love the diversified portfolio, but I'm not so sure you want to be in the alternatives. They're much more volatile," Baum said. "The average investors doesn't have that much money to put in there that it will make a difference if the market drops. I would rather just put some money in cash."

—By CNBC's Jeff Cox. Follow him on Twitter @JeffCoxCNBCcom.