What is a 'Benchmark For Correlation Values'

Benchmark for correlation values is a term that refers to a benchmark, or specific point of reference, that an investment fund uses to measure important correlation values such as beta, which measures the volatility of a security to the market as a whole, or R-squared, a statistical measure that shows how much of the variance for a dependent variable can be explained by an independent variable.

BREAKING DOWN 'Benchmark For Correlation Values'

Benchmark correlation values are important, as they indicate the degree to which a given fund's performance is related to its market, using the benchmark as a proxy for the market. For instance, a high correlation to a fund's benchmark is generally considered to be favorable for the fund if their investment thesis closely follows the benchmark.

A benchmark for correlation values depends on the investment mandate of a particular fund. For example, a large-cap U.S. equity fund would probably use the S&P 500 as its benchmark for correlation values, while a large-cap Canadian equity fund might use the S&P/TSX Composite Index as its benchmark.

A correlation coefficient is a statistic that measures how strong the relationship is between two variables.

If the ranges of values is between -1.0 and 1.0, a correlation of -1.0 shows a perfect negative correlation; a correlation of 1.0 shows a perfect positive correlation. A correlation of 0.0 shows zero or no relationship between the movement of the two variables.

Why a Benchmark For Correlation Values is Important

An awareness of how your investments correlate is important to knowing how to manage a particular portfolio's risk. If too many of your investments are highly correlated, if one of them takes a downturn, many others or all of them will too.

Correlation is based on the relationship between the prices of different assets. It measures how likely the price of two assets are to moved together, and does so on a  of -1 to 1. For example, if two assets both have a correlation of 1, then they are positively correlated and will moved in the save direction, up or down, at all times. Assets with negative correlation, a value of -1, move in opposite directions at all time. Assets with a correlation of 0 move in the same direction 50 percent of the time.

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, though actual will numbers will vary depending on an investor's risk tolerance. For example, risk averse investors will want as little correlation as possible. 

 

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