Correlation Between Small Cap and Large Cap

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

By analyzing existing cross correlation between Small Cap Equity and Large Cap Core, you can compare the effects of market volatilities on Small Cap and Large 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 Large Cap. Check out your portfolio center. Please also check ongoing floating volatility patterns of Small Cap and Large Cap.

Diversification Opportunities for Small Cap and Large Cap

0.96

Correlation Coefficient

Small Cap  Large Cap

Almost no diversification

The 3 months correlation between Small and Large is 0.96. Overlapping area represents the amount of risk that can be diversified away by holding Small Cap Equity and Large Cap Core in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Large Cap Core 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 Equity are associated (or correlated) with Large Cap. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of Large Cap Core has no effect on the direction of Small Cap i.e., Small Cap and Large Cap go up and down completely randomly.

Pair Corralation between Small Cap and Large Cap

Assuming the 90 days horizon Small Cap is expected to generate 1.08 times less return on investment than Large Cap. In addition to that, Small Cap is 1.53 times more volatile than Large Cap Core. It trades about 0.07 of its total potential returns per unit of risk. Large Cap Core is currently generating about 0.12 per unit of volatility. If you would invest  1,949  in Large Cap Core on May 2, 2025 and sell it today you would earn a total of  120.00  from holding Large Cap Core or generate 6.16% return on investment over 90 days.

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

Small Cap Equity  vs.  Large Cap Core

Small Cap Equity

Risk-Adjusted Performance

Modest

Compared to the overall equity markets, risk-adjusted returns on investments in Small Cap Equity are ranked lower than 5 (%) of all funds and portfolios of funds over the last 90 days. In spite of fairly strong fundamental indicators, Small Cap is not utilizing all of its potentials. The current stock price disturbance, may contribute to short-term losses for the investors.

Large Cap Core

Risk-Adjusted Performance

Good

Compared to the overall equity markets, risk-adjusted returns on investments in Large Cap Core are ranked lower than 9 (%) of all funds and portfolios of funds over the last 90 days. In spite of fairly weak forward indicators, Large Cap may actually be approaching a critical reversion point that can send shares even higher in August 2025.

Pair Trading with Small Cap and Large Cap

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

The idea behind Small Cap Equity and Large Cap Core 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 Bond Analysis module to evaluate and analyze corporate bonds as a potential investment for your portfolios..