Correlation Between Small Cap and Emerging Economies

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

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

Diversification Opportunities for Small Cap and Emerging Economies

0.98

Correlation Coefficient

Small Cap  Emerging Economies

Almost no diversification

The 3 months correlation between Small and Emerging is 0.98. Overlapping area represents the amount of risk that can be diversified away by holding Small Cap Index and Emerging Economies Fund in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Emerging Economies 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 Index are associated (or correlated) with Emerging Economies. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of Emerging Economies has no effect on the direction of Small Cap i.e., Small Cap and Emerging Economies go up and down completely randomly.

Pair Corralation between Small Cap and Emerging Economies

Assuming the 90 days horizon Small Cap Index is expected to generate 1.54 times more return on investment than Emerging Economies. However, Small Cap is 1.54 times more volatile than Emerging Economies Fund. It trades about 0.28 of its potential returns per unit of risk. Emerging Economies Fund is currently generating about 0.35 per unit of risk. If you would invest  1,296  in Small Cap Index on April 21, 2025 and sell it today you would earn a total of  284.00  from holding Small Cap Index or generate 21.91% 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 Index  vs.  Emerging Economies Fund

Small Cap Index

Risk-Adjusted Performance

Solid

Compared to the overall equity markets, risk-adjusted returns on investments in Small Cap Index are ranked lower than 21 (%) of all funds and portfolios of funds over the last 90 days. In spite of fairly weak essential indicators, Small Cap showed solid returns over the last few months and may actually be approaching a breakup point.

Emerging Economies

Risk-Adjusted Performance

Strong

Compared to the overall equity markets, risk-adjusted returns on investments in Emerging Economies Fund are ranked lower than 27 (%) of all funds and portfolios of funds over the last 90 days. In spite of fairly weak technical and fundamental indicators, Emerging Economies showed solid returns over the last few months and may actually be approaching a breakup point.

Pair Trading with Small Cap and Emerging Economies

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

The idea behind Small Cap Index and Emerging Economies Fund 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 Risk-Return Analysis module to view associations between returns expected from investment and the risk you assume.