Benchmark for Correlation Values
What Is a Benchmark for Correlation Values?
A benchmark for correlation values is a benchmark, or specific point of reference, that an investment fund or individual investor uses to measure important correlation values of their portfolios, for example, beta, which measures the volatility of a security to the market as a whole, or R-squared, a statistical measure that demonstrates the way that a significant part of the variance for a dependent variable can be made sense of by an independent variable.
Understanding a Benchmark for Correlation Values
Benchmark correlation values are important, as they show the degree to which a given fund's performance is related to its market, utilizing the benchmark as a proxy for that market. For example, a high correlation to a fund's benchmark is generally considered to be favorable for the fund on the off chance that their investment thesis closely follows the benchmark.
A benchmark for correlation values relies upon the investment order of a particular fund. For instance, a large-cap U.S. equity fund would probably utilize the S&P 500 as its benchmark for correlation values, while a large-cap Canadian equity fund could utilize the S&P/TSX Composite Index as its benchmark.
The correlation between a fund's specific metrics to those of its benchmark can be measured utilizing a correlation coefficient. A correlation coefficient is a statistic that measures how strong the relationship is between two variables.
Assuming that the range of values is between - 1.0 and 1.0, a correlation of - 1.0 shows a perfect negative correlation; implying that the two variables are not by any stretch in arrangement, while a correlation of 1.0 shows a perfect positive correlation, it are closely following each other to demonstrate that the variables. A correlation of 0 shows zero or no relationship between the movement of the two variables.
The Importance of a Benchmark for Correlation Values
An awareness of how your investments correlate is important in knowing how to deal with a particular portfolio's risk. In the event that your investment strategy is intended to follow that of a specific benchmark, for example, an index, then check how financial metrics in your portfolio compare to those in the benchmark. This will permit you to check assuming that your investments are on track, the condition of your portfolio's risk, and other important factors.
A benchmark for correlation values serves as an aide and can tell a portfolio manager in the event that any changes should be made in the portfolio. It will likewise demonstrate how the portfolio could perform from now on, which can help prepare for any losses.
Correlation of Assets in a Portfolio
Correlation depends on the relationship between the prices of different assets. It measures how likely the price of two assets move together, and does as such inside a - 1 to 1 range. For instance, on the off chance that two assets both have a correlation of 1, they are positively correlated and will move in a similar direction, up or down, consistently.
So assuming that you are just invested in stocks in the technology sector, which would probably have a correlation of 1, and new regulation is passed by the government that hurts the business growth of tech stocks, your entire portfolio will be negatively impacted.
Assets with a negative correlation, a value of - 1, maneuver in inverse directions consistently. Assets with a correlation of 0 move in a similar direction half of the time.
On the off chance that too a significant number of your investments are highly correlated, assuming one of them suffers a loss, numerous others or every one of them will too.
Diversification to Reduce Correlation Values
As a rule of thumb, it's generally considered to be prudent for assets to have a correlation range between - 0.5 and around 0.5, however genuine numbers will vary contingent upon an investor's risk tolerance. For instance, risk-averse investors will need as little correlation as could really be expected. This is additionally the thought behind diversification.
A diversified portfolio contains assets that have little correlation with each other. There might be a certain amount of assets that do correlate, yet there are likewise enough that don't correlate, so an adverse market move in one area probably won't influence the other, limiting losses.
Highlights
- Common correlation metrics that are measured against benchmarks incorporate beta and R-squared.
- Diversification can assist with reducing correlation among assets in a portfolio, which mitigates losses in market-specific downturns.
- A benchmark for correlation values is a point of reference that an investment fund utilizations to measure the correlation of financial metrics.
- A benchmark correlation value is utilized to show the degree to which a portfolio's performance is related to its market, particularly the benchmark that serves as a proxy for the market or the fund's expected investment strategy.
- A correlation coefficient is utilized to measure how strong a relationship is between two variables.
- Most frequently correlation coefficient values range between - 1.0 and 1.0, with - 1.0 showing the least correlation and 1.0 demonstrating the highest correlation.
