Investment Strategy

Looking at diversification beyond correlations

Correlations between assets have increased in recent years, with U.S. large-cap equity’s 20-year correlations with developed-market (DM) ex-U.S. equities, emerging-market (EM) equities, global hedge funds, and commodities all at or near highs (see Chart 1). Meanwhile, the correlation between U.S. stocks and bonds is still well below its high from the 1980s, being just above zero after years of being negative following the shift away from near-zero short-term interest rates. Overall, this means that we have observed more instances of U.S. stocks and various asset prices moving in the same direction than in the past. However, we believe these correlations do not tell the full story and more so show the general relationship between two assets over time.

Chart 1. 20-year correlations with U.S. large-cap equities have increased recentlySources: © Morningstar Direct, All Rights Reserved,¹ and Wells Fargo Investment Institute. Quarterly data from January 1, 1946, to December 31, 2025. IG = investment grade. Correlation measures the degree to which asset classes move in sync; it does not measure the magnitude of that movement. There is no guarantee that future correlations between the Indexes will remain the same. U.S. Large Cap Equities: S&P 500 Index. U.S. Taxable Investment Grade Fixed Income: Blend of IA SBBI U.S. Long-Term Government Bond Index and IA SBBI U.S. Long-Term Corporate Bond Index until 1976, and then the Bloomberg U.S. Aggregate Bond Index. Commodities: Bloomberg Commodity Index. Developed Market ex. U.S. equities: MSCI EAFE Index (Europe, Australasia, Far East) Index. Emerging Market Equities: MSCI Emerging Markets Index. Global Hedge Funds: HFRI Hedge Fund Weighted Composite Index. Index returns do not represent investment performance or the results of actual trading. Index returns reflect general market results, assume the reinvestment of dividends and other distributions, and do not reflect deduction for fees, expenses or taxes applicable to an actual investment. Past performance does not guarantee future results. Correlation measures the degree to which asset classes move in sync; it does not measure the magnitude of that movement. The risk associated with the representative asset classes and the definitions of the indexes are provided at the end of report.

One common goal of portfolio diversification is to avoid large drawdowns, which can take time to recover from and may impact investors psychologically, making strict adherence to their investment plan more difficult. To this end, we believe holding assets that can gain or at least decline less when the asset that makes up a plurality of a portfolio declines is important. Over the past 20 years, the U.S. stock-bond correlation was positive and up significantly from 2017 low. Of the 20 quarters from Jan. 1, 2006 through Dec 31, 2025 where U.S. stocks declined, bonds performed better than large-cap equities in 18 of the 20 quarters (see Table 1 part A). That attribute of bonds has been valued historically and has been reflected in their low correlations with equities.

Meanwhile, hedge funds have historically behaved differently from international equities despite also having a high correlation with U.S. stocks. While hedge funds have historically declined in tandem with U.S. stocks in 14 out of the 20 quarters, they showed less declines in 12 of those, meaning they experienced reduced downside participation, while rising in the remaining six quarters. In contrast, both DM ex-U.S. and EM equities historically declined more than the U.S. space roughly half the time, meaning they exacerbated the decline during drawdowns. Commodities are in between the other assets, having declined more than U.S. stocks in six out of the 20 quarters but gained while U.S. stocks declined in seven quarters.

On the other side, hedge funds historically have underperformed when U.S. stocks gained, rarely having outperformed or declined (see Table 1 part B). Bonds and international equities occasionally decline historically when U.S. stocks rose, though historically the latter has been more likely to be able to outperform, with EM equities doing so half the time on a quarterly basis over the 60 quarters measured when U.S. stocks showed gains. Commodities declined when U.S. stocks rose often, but they also outperformed a moderate amount.

Table 1: How other assets have moved compared to U.S. large-cap equities over the past 20 years

Part A: For quarters that U.S. stocks decline

What does the asset class do:	U.S. taxable IG fixed income	Commodities	DM ex-U.S. equities	EM equities	Global hedge funds
Gains	12	7	3	5	6
Declines less	6	7	6	5	12
Declines more	2	6	11	10	2

Part B: For quarters that U.S. stocks gain

What does the asset class do:	U.S. taxable IG fixed income	Commodities	DM ex-U.S. equities	EM equities	Global hedge funds
Gains more	7	14	23	30	4
Gains less	39	22	26	17	50
Declines	14	24	11	13	6

Sources: © Morningstar Direct, All Rights Reserved,¹ and Wells Fargo Investment Institute. Quarterly data from January 1, 2006, to December 31, 2025. IG = investment grade. U.S. stocks: S&P 500 Index. U.S. Taxable Investment Grade Fixed Income: Bloomberg U.S. Aggregate Bond Index. Commodities: Bloomberg Commodity Index. Developed Market ex. U.S. equities: MSCI EAFE Index (Europe, Australasia, Far East) Index. Emerging Market Equities: MSCI Emerging Markets Index. Global Hedge Funds: HFRI Hedge Fund Weighted Composite Index. Index returns do not represent investment performance or the results of actual trading. Index returns reflect general market results, assume the reinvestment of dividends and other distributions, and do not reflect deduction for fees, expenses or taxes applicable to an actual investment. Past performance does not guarantee future results. The risk associated with the representative asset classes and the definitions of the indexes are provided at the end of report.

With the U.S. suddenly involved in a war in the Middle East, now may be a good time to assess how we prefer to approach risk. War and COVID were negatives for equity markets, for example, but we look to the accelerating pace of automation (including artificial intelligence) as a potential positive that was largely not perceived by investors even a few years ago. Put simply, it may be possible to hedge against known risks (e.g., elections that come with regular frequency), but risks that arrive unpredictably and affect the economy can create a combination of upside and downside pressures across different asset classes. Over time, we see in such risks the potential to move markets as illustrated above. The unknown features of future risks lead us to prefer diversification.

Tailwinds continue supporting Emerging Market Equities

International equities have continued to outperform in 2026 following a strong 2025. So far this year, the MSCI EM Index and MSCI Developed Markets (DM) Index have outperformed the S&P 500 Index by 12% and 7%, respectively, as of March 2, 2026. Within international equities, EM have shined as the clear outperformer to start the year.

Behind EM’s strength is a subdued U.S. dollar, improving global macroeconomic conditions, and supportive government policies in select regions such as China. Additionally, sentiment around the asset class has improved following years of underperformance, and relatively cheaper valuations compared to its domestic counterparts have been an attractive characteristic for investors looking to reallocate amid concerns of frothy valuations in the tech-heavy S&P 500 Index.

Within EM, regions and sectors most exposed to AI and its critical resources appear to be among the outperformers (see Chart 2). This outperformance in the MSCI EM Index’s Information Technology (IT) sector is in stark contrast to the S&P 500 Index’s IT sector, which has underperformed the S&P 500 Index since October amid concerns of valuations and potential disruptions to the Software sub-industry as a result of AI. Notably, the EM IT sector is less weighted to software, which has been the center of weakness, compared to the U.S. IT sector. This heavier weighting in EM toward hardware and semiconductors could also help explain the difference in performances.

Looking ahead, we still believe the U.S. Large Cap Equities asset class displays the highest quality and a track record for strong earnings growth that should drive future returns. That said, we recognize the cyclical tailwinds and shift in sentiment supporting EM outperformance. We believe investors can benefit from an equal-weight allocation to the EM Equities asset class, especially considering that it offers exposure to key investment themes like the AI buildout, but with potentially cheaper valuations.

Chart 2. MSCI Emerging Market Index sector performancesSources: Bloomberg and Wells Fargo Investment Institute. Daily data is from December 31, 2025 – March 2, 2026. Past performance does not guarantee future results. An index is unmanaged and not available for direct investment.

Making sense of recent 10-year Treasury yield moves

For some perspective, these have been some recent 10-year U.S. Treasury yield levels. We finished 2025 at 4.17%. So far in 2026, the high was reached on January 20 at 4.29% and the low was on February 27 at 3.94%. Last week yields moved higher, a somewhat counter-to-expectations move after renewed conflict broke out in Iran. All in, the approximate year-to-date (as of March 3, 2026) range from 3.90% to 4.30% has been about 40 basis points wide (bps; 100 bps equal 1.00%).

Despite many major headlines in the past two months that implied yields should be moving higher, it appears that bond markets understood that the strong military presence building up in the Middle East in the past several weeks was signaling an imminent attack on Iran. For much of February, the 10-year yields kept moving lower — meaning bond prices higher — as investors appeared to be seeking refuge ahead of the attack.

In the first week of March, yields moved higher as renewed inflation concerns resurfaced. The threat of oil and energy prices moving higher due to prolonged military intervention was a key factor, but the latest readings of the Producer Price Index (PPI) and Institute for Supply Management (ISM) surveys of prices paid by businesses also ticked higher, signaling that inflation threats have been present even before the conflict broke out.

So, are 10-year yields moving higher or lower from here? In the near term there is still no clear path, as it will all depend on how all conflict-related events continue to transpire. Therefore, in our view, yields will most likely remain within the range mentioned above. However, looking past these immediate events, our bias is for yields to climb higher (bond prices lower), especially if positive U.S. macroeconomic fundamentals retake control. Our view is that consumer-led economic growth will move real (inflation-adjusted) interest rates higher. Inflation remains stickier for longer, and the term premium¹ also rises as U.S. Treasury issuance ramps up. The combined effect of these three factors should keep pressure on the 10-year yields to move higher toward our 2026 year-end target range of 4.25% – 4.75%.

¹ The term premium is defined as the compensation that investors require for bearing the risk that interest rates may change over the life of the bond. Federal Reserve Bank of New York.

Middle East conflict does not change our oil targets

Following the U.S. and Israeli strikes on Iranian military and government targets on February 28, West Texas Intermediate (WTI) oil prices surged to $76.55 as of March 3. We believe escalation risks remain elevated, with Iran having launched attacks on Saudi Arabia, the United Arab Emirates, and Bahrain. Concurrently, the U.K. and French have deployed warships to the region.

A key risk is Iran’s continued threat to target oil tankers, particularly if the Strait of Hormuz is credibly threatened. Roughly 20% of global oil and liquified natural gas flows through the Strait, and tanker traffic had already declined by roughly 40% – 50% as of March 1², not due to a military blockade but because ships are avoiding the area amid Iran–U.S. crossfire concerns.

In the near term, we expect prices to remain above our targets for year-end 2026 (WTI target of $60 – $70, Brent target of $65 – $75) considering the importance of the Strait of Hormuz and its proximity to major Organization of the Petroleum Exporting Countries (OPEC) producers. Iran has military assets in the Persian Gulf and in the Strait, but we do not expect them to attempt to close the passage, except as a last resort, because oil exports are the government’s main revenue source.

Most importantly, oversupply remains a headwind for oil prices to remain high. OPEC’S Monthly Oil Market Report indicates a surplus for 2025, with Organisation for Economic Co-operation and Development (OECD) inventories, oil on water, and days of forward consumption all rising to multi-year highs.

Absent a direct military confrontation between Iran and the U.S. in the Strait of Hormuz, oil price spikes are likely to be temporary rather than indicative of a structural loss of global supply, consistent with past episodes of regional conflict that reversed as tensions eased. We expect oil prices to drop once U.S.-Iran tensions cool and remain neutral on the Energy sector.

Chart 3. Oil prices surge amid geopolitical tension in the Middle EastSource: Bloomberg crude oil futures (WTI). Data as of March 3, 2026. MOM = month over month. USD = U.S. dollar.

² “Oil tanker traffic halts in Strait of Hormuz amid Gulf strikes.” S&P Global Commodity Insights, March 1, 2026.

Demystifying liquidity in direct lending

Private debt — particularly direct lending — has grown significantly in assets under management in recent years³, but the asset class is now facing increased scrutiny. Investors are paying closer attention to credit conditions, liquidity structures, and how emerging technologies such as artificial intelligence may affect certain business models. These concerns contributed to elevated redemption activity in many evergreen direct lending strategies late last year (see Chart 4), with the possibility that this trend could continue.

Direct lending is an illiquid strategy. Loans are privately originated, not publicly traded, and the secondary market remains limited, meaning lenders typically hold positions until repayment. Evergreen direct lending strategies may offer periodic liquidity options, but the redemptions are generally limited at the manager’s discretion. This limited liquidity may be supported by a liquidity sleeve. Additionally, managers in the space may use proceeds from loan repayments for redemptions, if it is deemed necessary.

While default rates⁴ in direct lending appear contained, we believe investors should evaluate credit quality and understand liquidity design when considering a private debt allocation. We prefer to consider managers that apply disciplined underwriting practices, including conservative loan‑to‑value ratios⁵ and financial leverage, a focus on senior secured positions, and a history of low defaults. Diversification across industries and companies can also help reduce idiosyncratic risk. Together, we believe these factors may help support portfolios to navigate varied credit and liquidity environments.

Chart 4. The redemption rate in evergreen direct lending strategies increased in Q4 2025Sources: Cliffwater, Wells Fargo Investment Institute. Data as of December 31, 2025. The data is based on Cliffwater Direct Lending Index – Perpetual. See disclosure for definitions.

Alternative investments, such as hedge funds, private equity, private debt and private real estate funds are not appropriate for all investors and are only open to “accredited” or “qualified” investors within the meaning of U.S. securities laws.

³ $1.85 trillion for private debt, as of June 30, 2025, according to Pitchbook “H1 2025 Global Private Debt Report,” September 21, 2025.

⁴ Cliffwater reported 1.45% default rate for Q3 2025; Proskauer reported 2.46% for Q4 2025 and 1.84% for Q3 2025.

⁵ loan-to-value is the ratio of the outstanding principal balance of a loan to the appraised value of the borrower.

Cash Alternatives and Fixed Income

Equities

Real Assets

Alternative Investments**

Source: Wells Fargo Investment Institute, March 9, 2026. Please see Wells Fargo Investment Institute's Asset Allocation Strategy Report for more detailed, investable ideas in each asset group.

*Tactical horizon is 6-18 months

**Alternative investments are not appropriate for all investors. They are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. Please see end of report for important definitions and disclosures.

Asset allocation and diversification are investment methods used to help manage risk. They do not guarantee investment returns or eliminate risk of loss including in a declining market.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. High yield (junk) bonds have lower credit ratings and are subject to greater risk of default and greater principal risk. Although Treasuries are considered free from credit risk they are subject to other types of risks. These risks include interest rate risk, which may cause the underlying value of the bond to fluctuate. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investing in a volatile and uncertain commodities market may cause a portfolio to rapidly increase or decrease in value which may result in greater share price volatility. Real estate has special risks including the possible illiquidity of underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions.

Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. This can result in greater price volatility. Communication Services companies are vulnerable to their products and services becoming outdated because of technological advancement and the innovation of competitors. Companies in the Communication Services sector may also be affected by rapid technology changes, pricing competition, large equipment upgrades, substantial capital requirements and government regulation and approval of products and services. In addition, companies within the industry may invest heavily in research and development which is not guaranteed to lead to successful implementation of the proposed product. Risks associated with the Consumer Discretionary sector include, among others, apparel price deflation due to low-cost entries, high inventory levels and pressure from e-commerce players, reduction in traditional advertising dollars, increasing household debt levels that could limit consumer appetite for discretionary purchases, declining consumer acceptance of new product introductions, and geopolitical uncertainty that could affect consumer sentiment. Consumer Staples industries can be significantly affected by competitive pricing particularly with respect to the growth of low-cost emerging market production, government regulation, the performance of the overall economy, interest rates, and consumer confidence. The Energy sector may be adversely affected by changes in worldwide energy prices, exploration, production spending, government regulation, and changes in exchange rates, depletion of natural resources, and risks that arise from extreme weather conditions. Investing in the Financial services companies will subject an investment to adverse economic or regulatory occurrences affecting the sector. Some of the risks associated with investment in the Health Care sector include competition on branded products, sales erosion due to cheaper alternatives, research and development risk, government regulations and government approval of products anticipated to enter the market. There is increased risk investing in the Industrials sector. The industries within the sector can be significantly affected by general market and economic conditions, competition, technological innovation, legislation and government regulations, among other things, all of which can significantly affect a portfolio’s performance. Materials industries can be significantly affected by the volatility of commodity prices, the exchange rate between foreign currency and the dollar, export/import concerns, worldwide competition, procurement and manufacturing and cost containment issues. Real estate investments have special risks, including possible illiquidity of the underlying properties, credit risk, interest rate fluctuations, and the impact of varied economic conditions. Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks, especially smaller, less-seasoned companies, tend to be more volatile than the overall market. Utilities are sensitive to changes in interest rates, and the securities within the sector can be volatile and may underperform in a slow economy.

Alternative investments, such as hedge funds, private equity/private debt and private real estate funds, are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. They entail significant risks that can include losses due to leveraging or other speculative investment practices, lack of liquidity, volatility of returns, restrictions on transferring interests in a fund, potential lack of diversification, absence and/or delay of information regarding valuations and pricing, complex tax structures and delays in tax reporting, less regulation and higher fees than mutual funds. Hedge fund, private equity, private debt and private real estate fund investing involves other material risks including capital loss and the loss of the entire amount invested. A fund's offering documents should be carefully reviewed prior to investing.

Hedge fund strategies, such as Equity Hedge, Event Driven, Macro and Relative Value, may expose investors to the risks associated with the use of short selling, leverage, derivatives and arbitrage methodologies. Short sales involve leverage and theoretically unlimited loss potential since the market price of securities sold short may continuously increase. The use of leverage in a portfolio varies by strategy. Leverage can significantly increase return potential but create greater risk of loss. Derivatives generally have implied leverage which can magnify volatility and may entail other risks such as market, interest rate, credit, counterparty and management risks. Arbitrage strategies expose a fund to the risk that the anticipated arbitrage opportunities will not develop as anticipated, resulting in potentially reduced returns or losses to the fund.

Investing in a direct lending perpetual fund involves significant risks, including the potential loss of principal. These funds typically invest in privately originated loans to corporate borrowers, which may be speculative, illiquid, and subject to limited regulatory oversight. An investment should be considered only by investors who can bear substantial risks and who do not require immediate liquidity. The fund invests primarily in loans to middle-market or non-investment-grade companies. Such borrowers often have higher leverage, limited operating histories, or cyclical business models, increasing the likelihood of: payment delays or defaults, covenant breaches, restructurings or bankruptcies. Losses on individual loans may be significant and could reduce or eliminate investor returns.

Bloomberg U.S. Aggregate Bond Index is composed of the Bloomberg U.S. Government/Credit Index and the Bloomberg U.S. Mortgage-Backed Securities Index and includes Treasury issues, agency issues, corporate bond issues, and mortgage-backed securities.

Bloomberg Commodity Index is a broadly diversified index of commodity futures on 20 physical commodities, subdivided into energy, U.S. agriculture, livestock, precious metals, and industrial metals sectors. Commodity weights are derived in a manner that attempts to fairly represent the importance of a diversified group of commodities to the world economy.

Cliffwater Direct Lending Index (CDLI) is an asset-weighted, quarterly index measuring the unlevered, gross-of-fees performance of U.S. middle-market corporate loans. It tracks over 20,000 loans held by business development companies (BDCs) through SEC filings.

CDLI-Perpetual (CDLI-P) is comprised primarily of loans held in perpetually structured, non-exchange-traded BDCs and was created to explore the comparative performance of this increasingly popular BDC structure against the entire universe of middle-market loans represented by CDLI.

HFRI Fund Weighted Composite Index is a global, equal-weighted index of over 2000 single-manager funds that report to HFR Database. Constituent funds report monthly net-of-all-fees performance in U.S. dollars and have a minimum of $50 Million under management or a 12-month track record of active performance. The HFRI Fund Weighted Composite Index does not include Funds of Hedge Funds.

IA SBBI U.S. Long-Term Corporate Bond Index is a custom index designed to measure the performance of long-term U.S. investment-grade corporate bonds.

IA SBBI U.S. Long-Term Government Bond Index is a custom index designed to measure the performance of long-term U.S. government bonds.

MSCI EAFE Index (Europe, Australasia, Far East) Index is a free-float-adjusted market-capitalization-weighted index designed to measure the equity market performance of developed markets, excluding the U.S. and Canada.

MSCI Emerging Markets Index is a free-float-adjusted market-capitalization-weighted index designed to measure equity market performance of emerging markets.

Producer Price Index (PPI) is a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time.

S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market-value-weighted index with each stock’s weight in the index proportionate to its market value.

An index is unmanaged and not available for direct investment.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability or best interest analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. The material contained herein has been prepared from sources and data we believe to be reliable but we make no guarantee to its accuracy or completeness.

Wells Fargo Advisors is registered with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors.

Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company.