Correlation Between Emerging Markets and Small Cap

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

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

Diversification Opportunities for Emerging Markets and Small Cap

0.96

Correlation Coefficient

Emerging Markets  Small Cap

Almost no diversification

The 3 months correlation between Emerging and Small is 0.96. Overlapping area represents the amount of risk that can be diversified away by holding Emerging Markets Fund and Small Cap Stock in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Small Cap Stock and Emerging Markets 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 Emerging Markets Fund 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 Stock has no effect on the direction of Emerging Markets i.e., Emerging Markets and Small Cap go up and down completely randomly.

Pair Corralation between Emerging Markets and Small Cap

Assuming the 90 days horizon Emerging Markets Fund is expected to generate 0.63 times more return on investment than Small Cap. However, Emerging Markets Fund is 1.58 times less risky than Small Cap. It trades about 0.33 of its potential returns per unit of risk. Small Cap Stock is currently generating about 0.2 per unit of risk. If you would invest  2,079  in Emerging Markets Fund on April 27, 2025 and sell it today you would earn a total of  327.00  from holding Emerging Markets Fund or generate 15.73% return on investment over 90 days.

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

Emerging Markets Fund  vs.  Small Cap Stock

Emerging Markets

Risk-Adjusted Performance

Solid

Compared to the overall equity markets, risk-adjusted returns on investments in Emerging Markets Fund are ranked lower than 25 (%) of all funds and portfolios of funds over the last 90 days. In spite of fairly weak primary indicators, Emerging Markets showed solid returns over the last few months and may actually be approaching a breakup point.

Small Cap Stock

Risk-Adjusted Performance

Solid

Compared to the overall equity markets, risk-adjusted returns on investments in Small Cap Stock are ranked lower than 16 (%) of all funds and portfolios of funds over the last 90 days. In spite of fairly weak fundamental indicators, Small Cap showed solid returns over the last few months and may actually be approaching a breakup point.

Pair Trading with Emerging Markets and Small Cap

The main advantage of trading using opposite Emerging Markets and Small Cap positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if Emerging Markets 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 Emerging Markets Fund and Small Cap Stock 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 Portfolio Rebalancing module to analyze risk-adjusted returns against different time horizons to find asset-allocation targets.