NEWS

Software risk or renaissance?

31 Mar 2026 - Magellan Investment Partners

31 Mar 2026 - Software risk or renaissance?

By: Magellan Investment Partners

Software risk or renaissance?

Magellan Investment Partners

February 2026

(5-minute read)

Artificial intelligence (AI) is driving a structural shift across the technology landscape. This transition has sparked recent fear regarding the long-term viability of traditional software vendors and their established business models. Much of this fear stems from the perceived disruptive threat of AI challengers and the falling cost of software development.

In our view, AI brings both risk and opportunity to software. It is a mistake to view the sector as a monolith. Software is as diverse as the applications and industry verticals it serves. Consequently, the impact of AI will vary significantly across the spectrum of vendors. When the market penalises the sector as if it were a homogeneous entity, it creates some opportunity to identify mispriced assets. We believe a number of enterprise software incumbents remain among the most attractive investment opportunities today.

What exactly are the concerns? We break these down to four distinct areas.

Lower cost of software development, enabling customers to rapidly build bespoke internal tools to replace incumbent solutions.
Accelerated competition from new software entrants who can exploit the same lower cost of development to come to market quickly.
Displacement of traditional software by AI-native applications that change how work is done.
Lower workforce headcount resulting from higher AI-driven productivity or professional displacement, affecting seat-based pricing models.

All of these concerns are both valid and, to some degree, observably taking place. The risk-weighted impact, however, depends on the software category and the software vendor being considered.

First, while AI does unlock productivity gains in coding, enterprise software is more than just packaged binaries. For example, a software customer may be acquiring embedded domain knowledge and industry best practice (such as in supply chain software) or technical specialisation and depth (such as electronic design automation). In-house development is not a one-and-done. A software customer is contracting with a proven vendor who provides continuous development, security and compliance, and service guarantees. It offloads complexity and development risk for the customers, who can then focus on core competencies while benefiting from the vendor's future product innovation.

Second, there are categories of software that have always been difficult to displace even in the face of competing options. Attributes contributing to this include systems of record, operational embedment, network effects or where outcomes must be deterministic and the cost of error is high. Enterprise Resource Planning (ERP) software is a category that ticks these boxes. Having access to AI alone does not change the long-standing reality that new entrants must contend with these barriers. Software risk or renaissance?

Third, AI is an openly accessible capability rather than the exclusive domain of new entrants. Incumbent vendors can find themselves better positioned to integrate AI into their existing suite and leverage its benefits for customers in a way that outside vendors would struggle to replicate. For the customer, adopting integrated AI features can be more effective and cost-efficient than stitching together disparate tools or risking a move to an unproven new platform.
Finally, there is material uncertainty regarding AI's future impact on the labour force. While workforce contraction in isolation could be a headwind for software vendors using seat-based pricing, those that can unlock higher productivity will capture their share of the value generated, regardless of the specific pricing mechanism. We are already seeing this take place with consumption models or new pricing tiers, such as the newly introduced Microsoft 365 E7 suite, which offers expanded agentic capabilities and is priced at a premium of over 70% to the preceding E5 tier.

AI is a transformative development, and we expect further emergence of compelling new applications that could change how people work. Because the software sector is so diverse, what this means for any given vendor depends on their specific circumstances. For some software names, AI will be disruptive and a risk to their business models. For the highest-quality software vendors like SAP, Microsoft and Intuit, AI is likely to bring a 'renaissance' of opportunity.

Adrian Lu, Senior Investment Analyst

Funds operated by this manager:

Magellan Global Fund (Open Class Units) ASX:MGOC , Magellan Infrastructure Fund , Magellan Global Opportunities Fund No.2 , Magellan Infrastructure Fund (Unhedged) , Magellan Global Fund (Hedged) , Magellan Core Infrastructure Fund , Magellan Global Opportunities Fund Active ETF (ASX:OPPT)

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Becoming wary of software

26 Mar 2026 - Challenger Investment Management

26 Mar 2026 - Becoming wary of software

By: Challenger Investment Management

Becoming wary of software

Challenger Investment Management

March 2026

(9-minute read)

Many of you will have seen news over the past few weeks regarding the US Private Credit sector's exposure to software and flow on concerns regarding the impact of AI on the software businesses. Investor concerns have centred around those managers who are most exposed with most press articles focussed on Blue Owl Capital as amongst the largest players in the private credit market they have the highest exposure.

Blue Owl was also in the press recently as they were forced to abandon a plan to have a listed fund which was trading at a circa 20% discount to NTA acquire units in an unlisted interval fund which had exceeded its 5% quarterly redemption cap.

There is a lot of news being reported and a lot for investors to digest in a rapidly evolving situation. In this note we have summarised what we think are the key points for investors to be thinking about at this time:

Software performance is fine (for now). Earnings have held up well, but the concerns related to how these businesses can sustain margins and growth with the threat of a cheaper and more efficient AI-alternative. Some will harness the power of AI to continue to grow and possibly even improve margins. Some will not.
Capital structures are the problem- acquisition multiples have declined sharply. US private credit firms have emphasised how they have lent to software businesses at 30-40% loan to value ratios but in aggressively structured formats (e.g. annual recurring revenue loans). With valuations having declined by 40% or more, LTVs have increased sharply. Even where earnings are growing at c. 5% annually, these loans are going to be far more difficult to refinance in the years to come. With this issue in mind many commenters are questioning how loan valuations have not been affected by the declines in equity valuations. We don't think this is unreasonable. The reality is that the market has been so hot that despite weaker fundamentals, loan valuations themselves have not been impacted. Blue Owl's Technology Finance Fund reported that in December 2025 the weighted average spread for all accruing floating rate new investments declined to 4.6%, down from 5.5% only 6 months prior. Competition has driven spreads tighter and loan valuations higher even in the face of higher loan to valuation ratios. Looking forward it may be different.
Fund flows matter- because of the scrutiny on the sector, many interval funds were already hitting their redemption gates in Q4 25, this will only worsen in Q1 26. Goldman reported redemption rates of 5% on average in Q4 with OTIC at 15.4% - the sector went from US$10bn in net flows in Q3 25 to less than US$4bn in Q4 25. Lack of capital makes it more difficult to extend and pretend as new money coming into the sector is going to want to be paid for the risk of a 60%+ LTV loan. We are already seeing asset sales (incl. some to related parties) to pay down debt and return capital to investors and activist investors getting involved in listed funds which are trading at material discounts - this will further tighten conditions. Many managers do have significant levels of institutional uncalled capital and leverage capacity. So, the flows story will be an evolving one.
Leverage only exacerbates the issue- in mid-2025 the RBA estimated global banks had US$300 billion in loans to private credit managers. The size of the US BDC credit market has grown to US$80 billion, from US$30 billion c. 2.5 years ago, a >40% CAGR. Over the past 12 months spreads have widened by c. 0.60% at a time when wider market spreads have been flat.

Turning to the domestic private credit market we think the following is important:

Exposure to software/AI redundancy risks are relatively low. We put software exposure in Australian private credit at less than 10%, less than half the exposure within US private credit markets
Investors still need to dig - there are domestic managers who have exposure to US private credit via joint ventures or even via investments in CLOs. It's not as simple as putting a line through all Australian managers and saying they are fine.
Fund flows matter here too. We have been warning for some time about the risks around governance practices and the potential for these to act as a catalyst for outflows and for similar outcomes.
The constant challenge for investors which is especially true in this environment is that the assessment of the risk of a fund is not just about the assets, it's not just about the manager and not just about their governance practices. A major determinant of outcomes will be how other investors respond. This is a much tougher proposition for investors to assess - size and scale matters here, access to institutional capital, transparency and approach to governance. A private credit firm with one open ended fund, poor valuation discipline, external leverage and lack of scale is far more exposed than the alternative.

The constant challenge for investors which is especially true in this environment is that the assessment of the risk of a fund is not just about the assets, it's not just about the manager and not just about their governance practices. A major determinant of outcomes will be how other investors respond. This is a much tougher proposition for investors to assess - size and scale matters here, access to institutional capital, transparency and approach to governance. A private credit firm with one open ended fund, poor valuation discipline, external leverage and lack of scale is far more exposed than the alternative.

Challenger IM Credit Income Fund , Challenger IM Multi-Sector Private Lending Fund

For Adviser & Investors Only

Disclaimer:

This material has been prepared by Challenger Investment Partners Limited (Challenger Investment Management or Challenger), ABN 29 092 382 842, AFSL 329 828.

This document does not relate to any financial or investment product or service and does not constitute or form part of any offer to sell, or any solicitation of any offer to subscribe or interests and the information provided is intended to be general in nature only. This should not form the basis of, or be relied upon for the purpose of, any investment decision. This document is not available to retail investors as defined under local laws.

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Emerging Markets: How AI concerns are impacting India

25 Mar 2026 - Pendal

Fears that rapid advances in artificial intelligence could slow global IT spending have weakened investor confidence in Indian software stocks.

25 Mar 2026 - Emerging Markets: How AI concerns are impacting India

By: Pendal

Emerging Markets: How AI concerns are impacting India

Pendal

March 2026

(5 minutes read time)

Fears that rapid advances in artificial intelligence could slow global IT spending have weakened investor confidence in Indian software stocks. Pendal's Global Emerging Markets Opportunities team investigates the implications for India's growth and current account balance.

THE explosion in capability of AI models in recent months has led some equity market participants to become more cautious about the outlook for various service sector industries, leading to selloffs in sectors from software to financial planning.

As investors who approach the asset-class primarily through top-down, country-level developments, the GEMO team has been thinking about what this might mean for India.

India is one of a group of emerging markets that tend to run current account deficits.

"These are countries that have significant latent domestic demand but where, for various historical, geographical or institutional reasons, domestic production falls short. These markets tend to have higher beta to global liquidity and risk appetite," says James Syme, senior fund manager, JOHCM.

"Most pertinently for India, the growth cycles of these countries tend to be constrained by inflation and external deficits, with both vulnerabilities reflecting demand running too far ahead of supply."

Since the end of 2010, India's current account deficit has averaged 1.7 per cent of GDP, although the maximum deficit was 5.1 per cent of GDP.

The structure of the current account balance has developed through time, and changed with India's economic cycle, but some components remain structurally important.

In 2025, India ran a deficit in non-oil goods of US$189 billion (4.9 per cent of GDP). Net oil imports were US$122 billion (3.2 per cent of GDP).

The resultant trade deficit of US$311 billion (8 per cent of GDP) was substantially offset by a net positive services balance of US$210 billion (5.4 per cent of GDP).

Notably, the surplus in IT services was US$227 billion (5.9 per cent of GDP). India also ran a positive income balance of US$85 billion (2.2 per cent of GDP), for an overall current account deficit of US$17 billion (0.4 per cent of GDP).

Syme says this relationship between IT service exports and oil imports is key for India's economy, and the two have grown together.

In fiscal year 2019, net IT service exports were US$85 billion, and oil imports were US$93.9 billion.

"The varying cycles in global IT service spending and the oil price are key for the health of the Indian economy," explains Syme.

At a time of higher oil prices, what does the downturn in sentiment towards software and IT service stocks mean for India?

In the first two months of 2026, the MSCI India IT Index has fallen over 20 per cent in USD terms.

"This is concerning, because the aggregate revenue of India's listed IT companies has a high correlation with the economy's IT service exports," says Syme.

If the negative outcome that stocks are pricing in comes to pass, particularly with higher oil prices, India's growth may be constrained by the current account balance.

"However, it is important to note that the 12-month forward consensus estimates for both the revenues and profits of the constituents of MSCI India IT Index have increased by 3.4 per cent year to date," notes Syme.

"This steady growth in the fundamental outlook for these companies suggests both opportunity in the sector, where we remain overweight, and ongoing support for the Indian economic growth story, although we remain underweight the country on valuation grounds.

"We do not feel that share price moves alone constitute a macro-level signal for India at this time."

Funds operated by this manager:

Pendal MicroCap Opportunities Fund , Pendal Global Select Fund - Class R , Pendal Sustainable Australian Fixed Interest Fund - Class R , Pendal Focus Australian Share Fund , Pendal Horizon Sustainable Australian Share Fund , Regnan Credit Impact Trust Fund , Pendal Sustainable Australian Share Fund , Pendal Sustainable Balanced Fund - Class R , Pendal Multi-Asset Target Return Fund

This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current as at December 8, 2021. PFSL is the responsible entity and issuer of units in the Pendal Multi-Asset Target Return Fund (Fund) ARSN: 623 987 968. A product disclosure statement (PDS) is available for the Fund and can be obtained by calling 1300 346 821 or visiting www.pendalgroup.com. The Target Market Determination (TMD) for the Fund is available at www.pendalgroup.com/ddo. You should obtain and consider the PDS and the TMD before deciding whether to acquire, continue to hold or dispose of units in the Fund. An investment in the Fund or any of the funds referred to in this web page is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested. This information is for general purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient's personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information. Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance. Any projections are predictive only and should not be relied upon when making an investment decision or recommendation. Whilst we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections. For more information, please call Customer Relations on 1300 346 821 8am to 6pm (Sydney time) or visit our website www.pendalgroup.com

Australian Secure Capital Fund - Property Update

24 Mar 2026 - Australian Secure Capital Fund

February was another strong month for Australian property values, posting a national rise of 0.8% for the second consecutive month. Perth (+2.3%) again led the way with a second straight monthly rise of greater than 2%... (1-minute read)

Glenmore Asset Management - Market Commentary

23 Mar 2026 - Glenmore Asset Management

The volatility of the last few months was amplified in
February due to reporting season, persistent AI disruption
fears and ongoing geopolitical tension. (2-minute read)

23 Mar 2026 - Glenmore Asset Management - Market Commentary

By: Glenmore Asset Management

Market Commentary - February

Glenmore Asset Management

March 2026

(2-minute read)

The volatility of the last few months was amplified in February due to reporting season, persistent AI disruption fears and ongoing geopolitical tensions. Domestically, large caps materially outperformed small/mid caps, resulting in the All Ordinaries Accumulation Index rising +3.3% compared to a -2.6% decline in the ASX Small Ordinaries Accumulation Index. The ASX50 had an extremely strong month, increasing by +7.9%, whilst at the smaller end, the Small Ords Industrials declined -4.5%. Capital light businesses, such as software and technology companies fell sharply due to investor fears around disruption from AI, whilst resources and mining services outperformed.

In comparing the fund's performance versus the benchmark in February, it should be noted the fund has a strong small/mid cap focus. Over the long term, there is clear evidence that these companies deliver superior returns to large caps, however during periods of investor risk aversion (such as the current environment where the RBA is raising interest rates to combat inflation), investor funds typically move out of small caps to the perceived safety of large cap companies.

In the US, the tech heavy NASDAQ was weighed down by similar factors, resulting in a -3.4% decline in the month, underperforming the S&P 500 which fell -0.9%. Outside of the US, the Euro Stoxx 50 and FTSE 100 maintained their recent momentum, rising +3.2% and +6.7%, respectively.

As we have discussed, the expectation of further RBA rate hikes has continued to drive a rotation back into large caps. Bluechip names rebounded in February, including CBA (+17%), NAB (+13%), BHP (+16%) and Woolworths (+16%). Whilst the market continues to expect 1-2 more RBA rate hikes over the next 12 months, past cycles have shown that the underperformance of small/mid caps tends to bottom well before the end of a rate hiking cycle.

In bond markets, the US 10-year bond yield recorded a sharp decline, falling -30 basis points (bp) to 3.94%, whilst its Australian counterpart fell -16bp to 4.65%. The Australian dollar continued to rise, increasing +2.2% to US$0.71, implying an increase of 1.5 cents.

Funds operated by this manager:

Glenmore Australian Equities Fund

Investment considerations of prolonged uncertainty over Iran

20 Mar 2026 - Janus Henderson Investors

Portfolio Manager Oliver Blackbourn and Global Head of Multi-Asset Adam Hetts assess the market implications of sustained conflict with Iran, examining energy shocks, inflation pressures, and what prolonged instability could mean for...

20 Mar 2026 - Investment considerations of prolonged uncertainty over Iran

By: Janus Henderson Investors

Investment considerations of prolonged uncertainty over Iran

Janus Henderson Investors

March 2026

(8-minute read)

The conflict in the Middle East has escalated over the last few days and hopes for a short war have faded. Regional diplomatic efforts to de-escalate appear to be failing and Iran continues to retaliate in response to strikes from the US and Israel. As a result, the Strait of Hormuz - the world's most important gateway for energy commodities - remains effectively closed to all but the most buccaneering of shipping companies.

The Strait closure is a result of a lack of insurance, firms not willing to risk the loss of future capacity if ships are sunk, and concerns for the welfare of sailors after several fatalities already. However, there are now risks of more intensive intervention from the US and/or Israel following reports that they are considering putting boots on the ground, either to try and extract Iranian enriched nuclear material or to take Kharg Island, a key sea terminal for Iranian oil exports. At the same time, a new Supreme Leader of Iran has been chosen who is seen as another hardliner. This is unlikely to be taken well by the US, who would have preferred someone more moderate, and the choice appears unlikely to create a path to de-escalation.

The desired end point is still uncertain

It is still not immediately clear what the ultimate objectives for the US and Israel are. Various intentions have been publicly stated but it is not clear which of these are red lines and which are just preferences. A further reduction of the potential for Iran to build nuclear weapons appears to be the closest to a requisite. However, given that strikes in 2025 were deemed to have achieved this, defining the outcome is difficult. Similarly, a desire to destroy Iran's long-range missile program has been expressed, but this may similarly be difficult to guarantee. Finally, regime change, either for military or humanitarian reasons, is now touted as a key objective, but it remains unclear how this can be achieved with airstrikes alone.

The objective matters

Understanding the motivating objectives is important when considering how long the war might last and the subsequent economic impact. We can look to several factors that suggest this could be a more prolonged campaign. Iran has indicated that it can continue with its current rate of response for six months, far longer than the weeks-long engagement that markets appeared to have been pricing. The US has expressed that it wishes to remove the previously enriched uranium that could be used in nuclear weapons, but it has been a long time since the last international inspection and its whereabouts are likely to be very uncertain. Similarly, the continuity of a new hardline leader suggests that Iran is feeling little pressure to change tack yet.

However, there are also ways in which the conflict could be wound up sooner. The most obvious is that US President Trump has shown a willingness to abruptly change direction on policy multiple times throughout his leadership, no matter the scale of the impact. With mid-term elections coming up later in the year, the US government is likely to be highly sensitive to anything that pushes up the cost of living. Therefore, finding a way to declare victory and return oil prices to lower levels may ultimately dominate any longer-term military objectives.

The length matters

A longer-term conflict raises the danger of greater destabilisation in the region, creates greater potential for more severe damage to key infrastructure and risks longer-lasting impact on energy supplies. While there are some ways to mitigate the impact in the near term, such as sending oil through pipelines to ports less likely to be targeted, or by releasing strategic reserves outside of the Middle East, these are either inherently temporary or lack the potential capacity to offset prolonged restrictions in the Strait of Hormuz.

Oil is often seen as the key commodity when considering conflicts in the Middle East, given its relevance to US gasoline prices in particular, but natural gas supplies are crucial for other regions, such as Europe, and other base products feed into areas from chemicals to fertilisers. Last week, markets appeared to be pricing energy commodities in line with a short-term interruption to the ease of supply. Assumptions around this appear to have changed over the weekend, with prices now moving to incorporate greater risk of a prolonged engagement. The lack of clarity around the US/Israeli objectives does nothing to reduce the uncertainty that markets hate.

Impact on markets

The price of oil has spiked above US$100 per barrel as concerns about supplies have intensified. European natural gas prices have almost doubled since the end of February. This is raising the spectre of the inflationary impulse generated by the Russian invasion of Ukraine in early 2022 and the subsequent removal of much of the Russian supply into energy markets.

Concerns about a jump in European inflation or simply prolonged stickiness in the US are lifting bond yields. US Treasury yields have moved higher as markets have taken out one of the US Federal Reserve interest rate cuts that were anticipated by the end of the year. Yields on 10-year Treasuries have seen less movement than their European counterparts, as US jobs numbers on Friday served to offset some upward yield pressure from expected inflation.

Concerns about inflation have seen surges in German and UK breakeven rates, with market pricing for the European Central Bank interest rates at the end of 2026 now looking at over 1.5 hikes. Since the end of February, expectations for the Bank of England have shifted from two cuts by the end of 2026 to a better than 50:50 chance that there will be an interest rate hike - a marked shift in the outlook. Markets are now pricing in higher oil prices for the foreseeable future, with concerns mounting about a stagflationary outcome, should higher energy costs stall a re-acceleration in economic growth.

The uncertainty has provided support for the much-maligned US dollar, given the American economy is looking better set to weather an energy shock than elsewhere. However, higher bond yields and a stronger greenback have dampened gold's ability to rally in the current environment, following strong performance during other recent periods of volatility.

Equity markets are seeing something of a reversal of recent performance dynamics. Markets that started the year positively, to the end of February, suddenly look under greater pressure. A stronger dollar and higher oil prices are weighing on Asian stocks that had been surging in the first two months of the year. Gas prices remain Europe's geopolitical Achilles heel and markets are clearly concerned that the region is overly exposed again. In the US, last week saw some signs of a reversal of the recent outperformance of Value stocks over their Growth counterparts. AI-related stocks have struggled in 2026 so far compared to the rest of the market, but the fears that higher oil prices could dent the very rosy economic outlook are leading to something of a reconsideration.

The effective closure of the Strait of Hormuz is unprecedented, undoubtedly making for severe impacts on risk assets. However, to put the sell-off in proper context, investors must also recognise that equities entered the conflict trading at a meaningful premium over historical valuation levels. The forward price/earnings ratios (P/Es) of major global equity markets were at top quartile levels versus their 20-year histories[1], roughly a 15%-30% premium compared to median levels. Indeed, the markets experiencing the largest sell-offs are the ones that entered the conflict with the highest returns year to date[2].

Risks of a prolonged war but don't rule out a quick "victory"

Situations like this demonstrate the value of well-diversified multi-asset portfolios. Geopolitical events are rarely easy to gain complete clarity on, with the current US administration apparently embracing uncertainty as a negotiation strategy. What we can take away from the events of the last few days is that it is likely the conflict could last longer than many had initially hoped. This means there is the potential for greater economic impact - and markets have moved to price in this change.

There is the potential for faster inflation and slower economic growth, with assets focusing on different aspects thus far. However, risks remain two-sided. US political pressures means that a quick "victory" should not be ruled out. Asset prices, driven by energy prices, are likely to swing violently as investors alter their expectations for either outcome.

[1] Source: Datastream, 27 February 2026. Past performance does not predict future returns.

[2] Source: Bloomberg, 31 December 2025 to 9 March 2026. Past performance does not predict future returns.

Funds operated by this manager:

Janus Henderson Australian Fixed Interest Fund , Janus Henderson Conservative Fixed Interest Fund , Janus Henderson Diversified Credit Fund , Janus Henderson Global Natural Resources Fund , Janus Henderson Tactical Income Fund , Janus Henderson Australian Fixed Interest Fund - Institutional , Janus Henderson Conservative Fixed Interest Fund - Institutional , Janus Henderson Cash Fund - Institutional , Janus Henderson Global Multi-Strategy Fund , Janus Henderson Global Sustainable Equity Fund , Janus Henderson Sustainable Credit Fund

All opinions and estimates in this information are subject to change without notice and are the views of the author at the time of publication. Janus Henderson is not under any obligation to update this information to the extent that it is or becomes out of date or incorrect. The information herein shall not in any way constitute advice or an invitation to invest. It is solely for information purposes and subject to change without notice. This information does not purport to be a comprehensive statement or description of any markets or securities referred to within. Any references to individual securities do not constitute a securities recommendation. Past performance is not indicative of future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

Whilst Janus Henderson believe that the information is correct at the date of publication, no warranty or representation is given to this effect and no responsibility can be accepted by Janus Henderson to any end users for any action taken on the basis of this information.

Correlation and How to Think About Diversifying Alternatives

19 Mar 2026 - Fidante

Achieving diversification and uncorrelated returns are a common objective when constructing investment portfolios. (5-minute read)

19 Mar 2026 - Correlation and How to Think About Diversifying Alternatives

By: Fidante

Correlation and How to Think About Diversifying Alternatives

Fidante

February 2026

(7-minute read)

Achieving diversification and uncorrelated returns are a common objective when constructing investment portfolios. Understanding what those terms really mean is essential to properly appreciate how alternative investments can contribute to robust long-term portfolios.

This article will explore how correlation works and the diversification benefits delivered by low correlation. We demonstrate how even small changes in correlation between assets can have a significant impact on portfolio performance. We also highlight the potential challenges when determining the correlation between assets and the key factors investors should consider in order to maximise the benefits of uncorrelated investments.

What is correlation?

Correlation is a statistical measure of the relationship between the returns of two investments (rather than price levels). It ranges from -1 to +1. Investments with high correlation tend to move in the same direction at the same time, while investments with little or no correlation tend to move independently of each other. Negatively correlated investments tend to move in opposite directions.

Importantly, two investments that both deliver positive long-term returns can nevertheless exhibit zero or even negative correlation. Conversely, investments that appear to move in opposite directions over time can be positively correlated. For example, daily price movements may show a very different relationship from the point to point one-year return.

In figure 1, at first glance it may appear that the two investments shown in the left-hand chart below are positively correlated. After all, for the period shown, both have increased by about the same amount. Looking at the daily returns in the chart on the right, we can see that most days the two investments do indeed move up together, however, on some days they move in opposite directions. Counterintuitively, the correlation of these two strategies turns out to be zero. An important implication is that investors can derive diversification benefits from two investments that both go up over time.

It's also important to note that statistically high correlation does not imply causation. Just because two return series are highly correlated does not mean one necessarily causes the other to move. As a result, correlation can and does change over time.

Furthermore, correlation tells us whether investments move together, but not the magnitude of the moves. Two investments may be highly correlated but exhibit very different-sized gains or losses.

In summary:

Correlation measures the relationship between the returns of two investments.
Two investments that move in the same direction over time can be uncorrelated and two investments that move in opposite directions over time can be positively correlated.
Correlation can change over time.
Correlation can't tell us how much one investment will move for a given move in another.

Why does correlation matter?

By combining uncorrelated investments, we can construct portfolios with lower risk and/or higher returns. This is the power of diversification. The lower the correlation between assets, the greater the potential benefit. This is where alternatives come in - no other asset class offers the same variety and breadth of uncorrelated investments as the universe of alternative investments.

This idea is often illustrated using the Markowitz Efficient Frontier1, which shows the combinations of investments that deliver the highest expected return for a given level of risk. Adding investments with positive expected returns and low correlation can improve a portfolio's position on this risk-return spectrum, allowing investors to achieve better outcomes without necessarily taking on more risk.

A simple illustration

To see why uncorrelated assets produce better portfolios, consider two investments, A and B. Both are expected to return 10% per year and each has volatility of 10%.

Figure 3 shows that when these investments are highly correlated, combining them does little to reduce portfolio risk. However, when correlation is low or even negative, portfolio volatility drops to levels far below that of either A or B individually, even though expected returns remain the same. This leads to higher risk adjusted returns - the portfolio earns the same return with less volatility.

The effect becomes even more powerful in larger diversified portfolios. Consider an equally weighted portfolio of 50 completely uncorrelated investments, all with the same ex-ante expected return and ex-ante volatility and a modestly positive Sharpe Ratio² of 0.3. The portfolio returns are shown by the green line on the left-hand chart, and the Sharpe Ratio is now 1.94, a significant improvement on any individual investment. However, even a small increases in correlation can significantly dilute these benefits. If these 50 investments now have a pair-wise correlation of 0.25 (still a relatively low correlation), the cumulative portfolio return becomes dramatically lower than when correlation was zero, as shown by the blue line in the right-hand chart.

\While the above is a contrived example from a simulation, it illustrates just how powerful the combination of uncorrelated investments can be. This is where alternatives have the potential to play such an important role in investment portfolios.

In practice, it is extremely difficult to find large numbers of investments that are truly uncorrelated at all times. However, each additional uncorrelated investment introduced into a portfolio increases the potential diversification benefits for the portfolio. Alternative investments are often uncorrelated not only to traditional assets like equities and bonds, but also to each other, making a rich hunting ground for investors seeking to maximise the power of diversification.

There is, however, an important caveat. Just as low or negative correlation enhances diversification, even small changes in correlation can undermine it, sometimes quickly and unexpectedly.

What factors affect correlation?

Correlation can increase during periods of market stress, economic shocks or major shifts in monetary policy. Events such as the COVID market sell off in early 2020 saw correlations spike as many assets moved sharply lower at the same time. Even if only temporary, this can have a devastating impact on portfolios if previously uncorrelated investments all move in the same direction at the same time.

The experience of 2022 provided another stark example. Rising interest rates negatively affected both equities and bonds, causing the traditional 60/40 portfolio to suffer unusually large losses. Assets that investors expected to diversify one another instead moved together.

Understanding the common drivers of returns is therefore critical when thinking about how correlation might change. When many investments rely on similar economic factors, such as low interest rates, correlation can rise sharply when those conditions change, as we saw in 2022.

Some investors attempt to anticipate these shifts and rebalance portfolios accordingly. However, this can be difficult, so alternative investments that are less susceptible to correlation changes can be useful as 'anchor' diversifiers in a portfolio.

The challenges of measuring correlation

While uncorrelated investments can improve portfolio diversification and resilience, measuring correlation is not straightforward. There is no single measure to determine "true" correlation.

Investors need to consider:

The time period used (daily, monthly, quarterly data)
Whether correlation is stable or varies significantly over time
When correlation tends to increase, especially during market stress
Whether diversification is lost precisely when it is needed most

Useful techniques include examining rolling correlations, analysing how investments behave during market downturns and monitoring whether regime changes have altered the relationship between two investments.

It's also worth remembering that correlation is only one part of the investment decision. Some investments may be attractive because of their risk/return profiles, even if diversification benefits are modest.

Understanding the role of alternatives in diversification

While investors often think about alternative investments as a single category, they can play very different roles within a portfolio. Broadly, alternatives can be grouped into three types based on their primary objective: growth alternatives, which aim to enhance overall portfolio returns; diversifying alternatives, which seek to improve risk adjusted returns by delivering low or uncorrelated performance; and defensive alternatives, which are designed to provide an explicit buffer during periods of market stress. Understanding these distinctions is critical, as the value an alternative investment brings depends not just on its standalone return, but on how it interacts with the rest of the portfolio.

Correlation and diversification are particularly central to the second category of diversifying alternatives. Investments with low correlation can materially improve portfolio outcomes by reducing volatility without sacrificing expected returns. Diversifying alternatives can therefore allow investors to achieve better risk adjusted returns rather than simply higher absolute returns, improving the efficiency and resilience of the portfolio as a whole. In this sense, alternatives that consistently deliver diversification benefits can be among the most valuable long term building blocks in a well constructed investment portfolio.

Final thoughts

Correlation measures how investment returns move relative to one another, but it is not fixed and cannot be relied upon to remain stable. Because correlation is based on historical data, there is no guarantee that it won't change in the future.

That said, portfolios constructed with investments with low correlation can deliver higher returns for a given level of risk than those with more highly correlated investments. Correlation can therefore be an essential part of assessing any potential investment and is of particular importance when considering alternative investments.

A solid understanding of correlation, its applications and limitations allows investors to unlock the power of diversification. While correlations can change, alternative investments that deliver consistently low correlation to traditional assets can be particularly valuable in building more robust, resilient portfolios.

¹Markowitz, H.M. (March 1952). "Portfolio Selection". The Journal of Finance.
²The Sharpe Ratio is a commonly used metric which is calculated as the ratio of the excess return to the volatility of an investment. It can be interpreted as a measure of the return per unit of risk.

10k Words | March 2026

17 Mar 2026 - Equitable Investors

Precious metals reacted savagely on the Kevin Warsh Fed Chair nomination. The "AI" capital drain bites for hyperscalers at the same time AI's rapidly improving capabilities bites for technology services. (2-minute read)

17 Mar 2026 - 10k Words | March 2026

By: Equitable Investors

10k Words

Equitable Investors

March 2026

(2-minute read)

Geopolitical risk spikes. After a long period of significant divergence, long term bond yields and forecast earnings yields have reunited. Worth considering alongside the relative performance of "Growth" v "Value". Long-term inflation expectations seem to have stabilised at higher levels than was the case pre-COVID - possibly baking in higher volatility in inflation. Military action swung equity investors straying to emerging markets back to the US. That US market may be concentrated but its a lot less concentrated than the ASX - and in the current period of turbulence concentration has performed very differently relative to equal-weight portfolios in the two countries. There does seem to be more interest in active investing currently. Finally, we can't escape without a chart on the decline of listed SaaS valuations - but in the context of a convergence with unlisted AI valuations.

Geopolitical Risk Index relative performance to VIX (US volatility) over 1 year

Source: Caldara and Iacoviello, Koyfin

US 10-year bond yield v S&P 500 forward earnings yield

Source: Yardeni

Growth relative to Value (iShares Russell 1000 Growth / iShares Russell 1000 Value)

Source: Koyfin

US 10-Year Breakeven Inflation Rate - relatively stable for past three years

Source: Koyfin

Australian 10-year Breakeven Inflation Rate

Source: Equitable Investors, RBA

CPI (Australia) - standard deviation of quarter-on-quarter change (rolling 30 quarters)

Source: Equitable Investors, ABS

Global yield spreads matrix

Source: Koyfin

S&P 500 relative to FTSE Emerging Index - reversal post Iran attack

Source: Bloomberg

Equities concentration - top 10 holdings' dominance of Aus and US major benchmarks (using iShares ETF proxies)

Source: Equitable Investors, Koyfin

S&P/ASX 200 - Free-float weighted (AS51) v equal-weighted indices (XEW)

Source: Equitable Investors, Iress, Koyfin

S&P 500 ETFs - Free-float weighted (IVW) v equal-weighted (RSP)

Source: Equitable Investors, Koyfin

The number of active ETFs launched each year in the US

Source: Morningstar

Public SaaS valuations have converged with AI-led software

Source: Arcadia Capital via Archtis

Funds operated by this manager:

Equitable Investors Dragonfly Fund

Disclaimer

Past performance is not a reliable indicator of future performance. Fund returns are quoted net of all fees, expenses and accrued performance fees. Delivery of this report to a recipient should not be relied on as a representation that there has been no change since the preparation date in the affairs or financial condition of the Fund or the Trustee; or that the information contained in this report remains accurate or complete at any time after the preparation date. Equitable Investors Pty Ltd (EI) does not guarantee or make any representation or warranty as to the accuracy or completeness of the information in this report. To the extent permitted by law, EI disclaims all liability that may otherwise arise due to any information in this report being inaccurate or information being omitted. This report does not take into account the particular investment objectives, financial situation and needs of potential investors. Before making a decision to invest in the Fund the recipient should obtain professional advice. This report does not purport to contain all the information that the recipient may require to evaluate a possible investment in the Fund. The recipient should conduct their own independent analysis of the Fund and refer to the current Information Memorandum, which is available from EI.

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31 Mar 2026 - Software risk or renaissance?

30 Mar 2026 - Waymo has 70 Humans Running 3000 Vehicles

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25 Mar 2026 - Emerging Markets: How AI concerns are impacting India

24 Mar 2026 - Australian Secure Capital Fund - Property Update

23 Mar 2026 - Glenmore Asset Management - Market Commentary

20 Mar 2026 - Investment considerations of prolonged uncertainty over Iran

The desired end point is still uncertain

The objective matters

The length matters

Impact on markets

Risks of a prolonged war but don't rule out a quick "victory"

19 Mar 2026 - Correlation and How to Think About Diversifying Alternatives

What is correlation?

Why does correlation matter?

A simple illustration

What factors affect correlation?

17 Mar 2026 - 10k Words | March 2026

13 Mar 2026 - Beyond 'Quality at any price'

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