Correlation Between Small Cap and Diversified Income

Can any of the company-specific risk be diversified away by investing in both Small Cap and Diversified Income at the same time? Although using a correlation coefficient on its own may not help to predict future stock returns, this module helps to understand the diversifiable risk of combining Small Cap and Diversified Income into the same portfolio, which is an essential part of the fundamental portfolio management process.

By analyzing existing cross correlation between Small Cap Value and Diversified Income Fund, you can compare the effects of market volatilities on Small Cap and Diversified Income and check how they will diversify away market risk if combined in the same portfolio for a given time horizon. You can also utilize pair trading strategies of matching a long position in Small Cap with a short position of Diversified Income. Check out your portfolio center. Please also check ongoing floating volatility patterns of Small Cap and Diversified Income.

Diversification Opportunities for Small Cap and Diversified Income

0.5

Correlation Coefficient

Small Cap  Diversified Income

Very weak diversification

The 3 months correlation between Small and Diversified is 0.5. Overlapping area represents the amount of risk that can be diversified away by holding Small Cap Value and Diversified Income Fund in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Diversified Income and Small Cap is a relative statistical measure of the degree to which these equity instruments tend to move together. The correlation coefficient measures the extent to which returns on Small Cap Value are associated (or correlated) with Diversified Income. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of Diversified Income has no effect on the direction of Small Cap i.e., Small Cap and Diversified Income go up and down completely randomly.

Pair Corralation between Small Cap and Diversified Income

Assuming the 90 days horizon Small Cap Value is expected to generate 4.37 times more return on investment than Diversified Income. However, Small Cap is 4.37 times more volatile than Diversified Income Fund. It trades about 0.03 of its potential returns per unit of risk. Diversified Income Fund is currently generating about 0.08 per unit of risk. If you would invest  954.00  in Small Cap Value on October 21, 2024 and sell it today you would earn a total of  126.00  from holding Small Cap Value or generate 13.21% return on investment over 90 days.

Time Period	3 Months [change]
Direction	Moves Together
Strength	Weak
Accuracy	100.0%
Values	Daily Returns

Small Cap Value  vs.  Diversified Income Fund

Small Cap Value

Risk-Adjusted Performance

0 of 100

Very Weak

Over the last 90 days Small Cap Value has generated negative risk-adjusted returns adding no value to fund investors. In spite of fairly strong forward indicators, Small Cap is not utilizing all of its potentials. The current stock price disturbance, may contribute to short-term losses for the investors.

Diversified Income

Risk-Adjusted Performance

2 of 100

Weak

Compared to the overall equity markets, risk-adjusted returns on investments in Diversified Income Fund are ranked lower than 2 (%) of all funds and portfolios of funds over the last 90 days. In spite of fairly strong basic indicators, Diversified Income is not utilizing all of its potentials. The current stock price disturbance, may contribute to short-term losses for the investors.

Pair Trading with Small Cap and Diversified Income

The main advantage of trading using opposite Small Cap and Diversified Income positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if Small Cap position performs unexpectedly, Diversified Income can make up some of the losses. Pair trading also minimizes risk from directional movements in the market. For example, if an entire industry or sector drops because of unexpected headlines, the short position in Diversified Income will offset losses from the drop in Diversified Income's long position.

The idea behind Small Cap Value and Diversified Income Fund pairs trading is to make the combined position market-neutral, meaning the overall market's direction will not affect its win or loss (or potential downside or upside). This can be achieved by designing a pairs trade with two highly correlated stocks or equities that operate in a similar space or sector, making it possible to obtain profits through simple and relatively low-risk investment.

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Note that this page's information should be used as a complementary analysis to find the right mix of equity instruments to add to your existing portfolios or create a brand new portfolio. You can also try the Balance Of Power module to check stock momentum by analyzing Balance Of Power indicator and other technical ratios.