How They Move Together

Expected returns and volatility tell you about individual assets. But portfolios are not built from individual assets in isolation — they're built from combinations of assets that interact with each other.

This is where correlation becomes the critical variable. Understanding how assets move together is arguably more important than knowing their individual expected returns.

What Is Correlation?

Correlation measures how two assets move in relation to each other. It ranges from -1 to +1:

• +1.0 (Perfect positive correlation): The two assets move in perfect lockstep. When one rises 5%, the other rises 5%. Holding both provides zero diversification benefit.
• 0.0 (No correlation): The assets have no systematic relationship. One might rise while the other falls, or vice versa. Combining them can significantly reduce portfolio volatility.
• -1.0 (Perfect negative correlation): The assets move in perfect opposition. When one rises, the other falls by the same amount. This is rare in practice but would provide maximum diversification.

The lower the correlation between assets, the more you benefit from holding them together. This is the mathematical foundation of diversification.

Why Correlation Matters More Than You Think

Consider two portfolios:

• Portfolio A: 100% in a single U.S. equity ETF
• Portfolio B: 50% in U.S. equities, 50% in gold

Both might have similar expected returns. But Portfolio B will almost certainly have lower volatility — because gold and stocks are uncorrelated. When stocks crash, gold often rises, cushioning the blow.

This is the free lunch of investing: you can reduce risk without necessarily sacrificing returns if you combine assets with low correlations.

The Challenge: Correlations Are Not Constant

Here's the complication: correlations shift with changing economic regimes and market structures.

A correlation observed in the last decade might not hold in the next if conditions change. For example, the stock-bond correlation was negative for most of the 2010s (stocks up = bonds down, and vice versa), but it turned positive in 2022 when both stocks and bonds fell together during the inflation shock.

Voya Investment Management notes that over 20 years, the average stock-bond correlation was approximately zero — but it oscillated from -0.10 in normal periods to +0.07 in turbulent periods. Relying blindly on long-run averages "offers little insight" if we don't account for these regime differences.

For the estimates below, I've combined historical analysis with forward-looking research from institutions like Morningstar, BlackRock, and State Street Global Advisors. Where ETFs are new (like MNZL or WSHR), I've used proxy indices — the underlying benchmarks they track — to estimate behavior. The goal is to capture long-run structural relationships, not short-term noise.

The Forward-Looking Correlation Matrix

The table below presents estimated correlations between the 12 ETFs in HalalFolio over a 5+ year investment horizon. Each value is the assumed correlation coefficient between the returns of each pair.

Key Observations from the Matrix

The Equity Cluster: High Correlation, Limited Diversification

Look at the equity funds: HLAL, SPUS, MNZL, WSHR, UMMA, SPWO, SPTE. Their correlations with each other range from 0.85 to 0.99.

The U.S. Shariah funds (HLAL, SPUS, MNZL) show ~0.99 correlation — they hold virtually identical baskets of large-cap stocks. From a pure diversification standpoint, holding more than one doesn't reduce portfolio risk. However, investors may choose multiple funds for other reasons: fee structures, platform availability, BDS screening preferences, or simply personal preference.

Global funds (WSHR, UMMA) correlate at ~0.95 with U.S. funds because U.S. stocks make up a large portion of global indices, and global macro factors affect all markets. International ex-U.S. stocks (SPWO) show a slightly lower correlation with U.S. stocks (~0.85), providing a modest diversification benefit — but Morningstar's research suggests this benefit has diminished over time as global markets have become more interconnected.

The technology fund (SPTE) correlates at 0.95 with broad U.S. equity because Shariah-compliant U.S. indices already overweight tech. Adding SPTE amplifies tech exposure rather than diversifying away from it.

The bottom line: From a correlation standpoint, all these equity funds form a single cluster. They will largely move together during major market events — rising in bull markets, falling in bear markets. Geographic or sector diversification within equities is real but limited.

The True Diversifiers: Gold, Sukuk, and Crypto

The assets that stand apart from the equity cluster are the true diversifiers:

Gold (GLDM): Near-zero correlation (~0.10) with every equity fund. Gold is driven by different forces — inflation hedging demand, central bank purchases, flight-to-safety during crises. These forces do not systematically coincide with stock market movements. In many historical drawdowns, gold rose while stocks fell. Over a full cycle, these bouts average out to near-zero correlation — but in the moments that matter most (market crashes), gold can provide meaningful downside protection.

Sukuk (SPSK): Very low correlation (~0.20 or below) with all equity funds, and zero with gold and crypto. Sukuk are driven by interest rate movements and credit spreads — fundamentally different forces than equity markets. Their low volatility and low correlation make them the portfolio's ballast.

Crypto (BTCC.B, ETHH.B): Moderate correlation (~0.30) with equities. This is lower than the correlation between equity funds, making crypto a potential diversifier. Crypto is still an evolving asset class. Its correlation with equities spiked during 2020-22, then began to moderate. Some analysts project it may become more "gold-like" over time as an alternative store of value. The key insight: Bitcoin and Ethereum are highly correlated with each other (0.80), so they function as a single crypto bucket, not separate diversifiers.

REITs: A Disappointing Diversifier

Real estate (SPRE) sits in an awkward middle ground. Its correlation with equities (~0.70) is lower than stocks-to-stocks, but much higher than gold-to-stocks or sukuk-to-stocks. As Morningstar's data shows, REITs have increasingly "behaved as stocks at the end of the day." They provide some diversification — but far less than their historical reputation suggests.

The Practical Implication

The correlation matrix reveals a fundamental truth about portfolio construction: true diversification requires different asset classes, not just different funds within the same asset class.

Holding five different U.S. equity ETFs doesn't meaningfully reduce risk — they all move together. The dramatic risk reduction comes from adding assets that march to different drummers: sukuk, gold, and potentially crypto.

This doesn't mean you should hold any particular mix. It means you should understand what diversification actually does and doesn't do, so you can make informed decisions about your own portfolio.

Sources

These correlation estimates are informed by:

• Morningstar: 2024 Diversification Landscape
• S&P Dow Jones Indices: How Indexing Affects Shariah-Compliant Investing
• Voya Investment Management: Capital Market Assumptions 2024
• State Street Global Advisors: Why Bitcoin Institutional Demand is on the Rise
• Bitwise Asset Management: Bitcoin Long-Term Capital Market Assumptions
• Historical index data from S&P, MSCI, and Dow Jones Islamic Market indices

These figures are updated periodically. Last update: Late 2025.