Correlation Between Investment Quality and Small Capitalization

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

By analyzing existing cross correlation between Investment Quality Bond and Small Capitalization Portfolio, you can compare the effects of market volatilities on Investment Quality and Small Capitalization 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 Investment Quality with a short position of Small Capitalization. Check out your portfolio center. Please also check ongoing floating volatility patterns of Investment Quality and Small Capitalization.

Diversification Opportunities for Investment Quality and Small Capitalization

-0.63

Correlation Coefficient

Investment Quality  Small Capitalization

Excellent diversification

The 3 months correlation between Investment and Small is -0.63. Overlapping area represents the amount of risk that can be diversified away by holding Investment Quality Bond and Small Capitalization Portfolio in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Small Capitalization and Investment Quality 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 Investment Quality Bond are associated (or correlated) with Small Capitalization. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of Small Capitalization has no effect on the direction of Investment Quality i.e., Investment Quality and Small Capitalization go up and down completely randomly.

Pair Corralation between Investment Quality and Small Capitalization

Assuming the 90 days horizon Investment Quality Bond is expected to under-perform the Small Capitalization. But the mutual fund apears to be less risky and, when comparing its historical volatility, Investment Quality Bond is 5.44 times less risky than Small Capitalization. The mutual fund trades about -0.06 of its potential returns per unit of risk. The Small Capitalization Portfolio is currently generating about 0.14 of returns per unit of risk over similar time horizon. If you would invest  108.00  in Small Capitalization Portfolio on September 2, 2024 and sell it today you would earn a total of  13.00  from holding Small Capitalization Portfolio or generate 12.04% return on investment over 90 days.

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

Investment Quality Bond  vs.  Small Capitalization Portfolio

Investment Quality Bond

Risk-Adjusted Performance

0 of 100

Very Weak

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

Small Capitalization

Risk-Adjusted Performance

10 of 100

OK

Compared to the overall equity markets, risk-adjusted returns on investments in Small Capitalization Portfolio are ranked lower than 10 (%) of all funds and portfolios of funds over the last 90 days. In spite of fairly weak fundamental indicators, Small Capitalization may actually be approaching a critical reversion point that can send shares even higher in January 2025.

Pair Trading with Investment Quality and Small Capitalization

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

The idea behind Investment Quality Bond and Small Capitalization Portfolio 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 Equity Forecasting module to use basic forecasting models to generate price predictions and determine price momentum.