Asset Correlation
Diversification is the only free lunch in finance, but it only works if assets are truly uncorrelated. During a liquidity crisis (a shift in market regime), correlations tend to converge to 1.0, rendering diversification useless.
In quantitative portfolios, the correlation coefficient between two strategies must be measured dynamically. A static 10-year correlation matrix will mask the short-term spikes in covariance that cause simultaneous drawdowns.
To measure the risk-adjusted return of a diversified portfolio, rely on the Sharpe Ratio, and project potential future states via Monte Carlo Simulations.