Correlation Between Small Cap and Broad Cap

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

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

Diversification Opportunities for Small Cap and Broad Cap

0.85

Correlation Coefficient

Small Cap  Broad Cap

Very poor diversification

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

Pair Corralation between Small Cap and Broad Cap

Assuming the 90 days horizon Small Cap Special is expected to under-perform the Broad Cap. In addition to that, Small Cap is 1.45 times more volatile than Broad Cap Value. It trades about -0.16 of its total potential returns per unit of risk. Broad Cap Value is currently generating about -0.05 per unit of volatility. 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

Small Cap Special  vs.  Broad Cap Value

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.

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.

Pair Trading with Small Cap and Broad Cap

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

The idea behind Small Cap Special and Broad Cap Value 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 AI Portfolio Architect module to use AI to generate optimal portfolios and find profitable investment opportunities.