Key takeaways
- Correlation measures your portfolio's co-movement with the overall market - on a scale from -1 to +1.
- +1 means perfect co-movement, 0 no linear relationship, -1 opposite movement.
- A high correlation means the market explains a large part of your fluctuations.
What is correlation?
Correlation describes how closely two series of values move together. Applied to your portfolio: does it rise and fall in the same rhythm as the overall market, or does it go its own way? The value always lies between -1 and +1:
- close to +1: strong co-movement - market up, portfolio up.
- close to 0: no discernible linear relationship.
- close to -1: opposite movement - one rises when the other falls.
Most broadly diversified equity portfolios have a high positive correlation with the world market because they largely hold the same companies.
Correlation and beta - the difference
Both metrics look at the relationship with the market, but from different angles:
| Metric | Answers the question | Range |
|---|---|---|
| Correlation | How close is the co-movement? | -1 to +1 |
| Beta | How large is the swing? | unbounded (typically around 1) |
A portfolio can react strongly to the market (high beta) even though the relationship is noisy (moderate correlation) - or move closely with it (high correlation) but in a muted way (beta below 1). Only together do they give a complete picture.
How Talantor calculates it
Talantor uses the same basis as for beta: weekly returns over up to five years against a broad world index (FTSE All-World). The correlation coefficient follows from how these pairs of returns move together.
Why this matters for diversification
Diversification works best when the building blocks behave differently - that is, when they have low correlation. A consistently high correlation across all positions is a sign that your portfolio is less diversified than the bare number of positions suggests.