Experienced investors know that markets can swing fast and swing together. For example, the 2008 upheaval in US mortgage markets helped trigger crashes in global stock markets. More recently, concerns over inflation and energy prices due to the war in Iran have impacted markets from stocks to crypto.

Unfortunately, this degree of correlation is a feature, rather than a bug, of finance. Investments that look very different and depend on very different sources can be exposed to the same economic pressures.

Some sources of yield, however, are less closely tied to market movements. Reinsurance, for example, is largely uncorrelated with them: it depends instead chiefly upon the performance of the actual underlying insurance operations.

But what does it mean for returns to be largely uncorrelated? What drives the likes of stocks, bonds, and crypto? Why is reinsurance different? And why hasn’t it seen more widespread adoption by investors? Let’s explore.

What is correlation?

Correlation describes how closely investment returns move together. Investments that tend to rise and fall together are positively correlated. Some investments may be strongly correlated because of the sector they're in, or because they respond similarly to changes in interest rates; for example, share prices across a range of industries can drop concurrently if investors expect a widespread slowdown in consumer spending. Because different asset classes can respond to the same market forces, correlation can extend across markets.

That's important for diversification. If you're holding several categories of assets but they're all strongly correlated, then you're lacking the protection that diversity is intended to provide: a major market event could negatively impact those assets at the same time.

When investments are largely uncorrelated, the performance of one will track that of the other very little, if at all.

Correlation within and across markets

Correlation can exist in assets both within a given market and across different markets. Stocks, bonds, and crypto each offer examples of how ostensibly diversified assets can respond concurrently to the same market pressures.

Stocks

Stock prices reflect what investors are willing to pay for a share of a business, and that depends in part on what they expect the business to earn. Those expectations can change for reasons well beyond the company itself. An otherwise well-run business might face higher fuel costs, more expensive borrowing, or customers with less money to spend. Investors may then expect lower profits and become less willing to pay the same price for its shares.

That helps explain why stocks in different sectors can fall together. Higher oil prices, for example, can increase costs for both an airline and a manufacturer, despite the differences between their businesses. A broader economic slowdown can reduce demand across many industries at once. The companies haven't become identical investments; they're simply exposed to the same problem.

Bonds

Bond investors lend money in exchange for specified payments. But those payments don't fix the price at which the bond can be sold. Suppose an investor holds a bond paying 3% interest, and comparable new bonds begin offering 5%. A buyer has little reason to pay the same price for the lower-paying bond, so its market value falls. A rise in interest rates can therefore reduce the value of many existing fixed-rate bonds simultaneously.

Borrowers' ability to repay also matters. An economic downturn can weaken the finances of multiple companies, making investors less confident that they'll receive the payments promised. Bonds issued by different businesses can consequently fall together, particularly where those businesses face similar financial difficulties.

Crypto

Crypto prices can change because of developments within a particular project, but sentiment can also spread across the industry. Investors becoming less willing to hold crypto can reduce demand for multiple tokens at once, including those belonging to projects that haven't experienced a specific setback.

Crypto’s trading mechanics can amplify that selling. Investors who have borrowed to increase their exposure may be forced to close positions as prices fall. Those liquidations create further selling, which can push prices down again. Holding several different tokens can therefore leave an investor exposed to a shared decline in demand and the selling that follows.

How those connections extend across markets

The same economic development can affect all three asset classes through different mechanisms. Rising interest rates can make borrowing more expensive for businesses, reducing expected profits and the prices investors will pay for their stocks. They can also reduce the resale value of existing fixed-rate bonds. Meanwhile, higher interest payments available elsewhere can make investors less willing to hold speculative assets such as crypto. The investments differ, but their prices can still fall in response to the same change in conditions.

Is reinsurance yield correlated with stocks, bonds, or crypto?

Reinsurance yield, the source of return behind Re, is largely uncorrelated with stocks, bonds, and crypto. Reinsurance is a major market in its own right, but it is driven by different forces than the primary financial markets. Underwriting performance depends almost exclusively upon the underlying insurance operations.

For the reinsurance-derived return, that means performance is driven by a simple formula: premiums earned from insurers on the one side, and the sum of claims and expenses on the other.

Underwriting performance isn't driven by sentiment, or speculation, or profit projections: market events that cause a fall in stock prices or a crypto sell-off typically have no real impact upon the premiums earned or the claims owed under reinsurance contracts.

Why isn't reinsurance in more portfolios?

All of the above raises an obvious question: why isn’t reinsurance ubiquitous in portfolios already?

The answer is simple: for the vast majority of its existence as a market, reinsurance has been almost exclusively the realm of a small number of major players. The steep capital requirements and need for industry relationships have set a prohibitively high barrier to entry.

Re changes that.

How does Re provide access to reinsurance yield?

Re democratizes access by sourcing capital from the DeFi markets. Participants deposit stablecoins to mint reUSD or reUSDe, yield-bearing tokens. A portion of user capital is deployed offchain to back reinsurance treaties, and underwriting revenue flows back to the protocol to support token yield. In short: individuals bypass the capital barriers, skip the industry relationships, and gain access to the market.

For a closer look at correlation across DeFi yield in particular, read Re and the Uncorrelated Market.