Correlation Between Broad Cap and Small Cap

Can any of the company-specific risk be diversified away by investing in both Broad Cap and Small Cap 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 Broad Cap and Small Cap into the same portfolio, which is an essential part of the fundamental portfolio management process.

By analyzing existing cross correlation between Broad Cap Value and Small Cap Special, you can compare the effects of market volatilities on Broad Cap and Small Cap 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 Broad Cap with a short position of Small Cap. Check out your portfolio center. Please also check ongoing floating volatility patterns of Broad Cap and Small Cap.

Diversification Opportunities for Broad Cap and Small Cap

0.85

Correlation Coefficient

Broad Cap  Small Cap

Very poor diversification

The 3 months correlation between Broad and Small is 0.85. Overlapping area represents the amount of risk that can be diversified away by holding Broad Cap Value and Small Cap Special in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Small Cap Special and Broad 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 Broad Cap Value are associated (or correlated) with Small Cap. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of Small Cap Special has no effect on the direction of Broad Cap i.e., Broad Cap and Small Cap go up and down completely randomly.

Pair Corralation between Broad Cap and Small Cap

Assuming the 90 days horizon Broad Cap Value is expected to generate 0.69 times more return on investment than Small Cap. However, Broad Cap Value is 1.45 times less risky than Small Cap. It trades about -0.05 of its potential returns per unit of risk. Small Cap Special is currently generating about -0.16 per unit of risk. If you would invest  1,478  in Broad Cap Value on December 28, 2024 and sell it today you would lose (47.00) from holding Broad Cap Value or give up 3.18% of portfolio value over 90 days.

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

Broad Cap Value  vs.  Small Cap Special

Broad Cap Value

Risk-Adjusted Performance

Very Weak

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

Small Cap Special

Risk-Adjusted Performance

Very Weak

Over the last 90 days Small Cap Special has generated negative risk-adjusted returns adding no value to fund investors. In spite of weak performance in the last few months, the Fund's basic indicators remain fairly strong which may send shares a bit higher in April 2025. The current disturbance may also be a sign of long term up-swing for the fund investors.

Pair Trading with Broad Cap and Small Cap

The main advantage of trading using opposite Broad Cap and Small Cap positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if Broad Cap position performs unexpectedly, Small Cap 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 Small Cap will offset losses from the drop in Small Cap's long position.

The idea behind Broad Cap Value and Small Cap Special 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 FinTech Suite module to use AI to screen and filter profitable investment opportunities.