It goes without saying that investors seek to make a positive return on their investment portfolios. Each investor forms investment portfolio very individually. Some rely more on investment rules, other less so. Either way, most investors rely on correlation as it plays a significant role in investment management. One of our potential customers asked to see how Algorithmic Trading Portfolio compares to other systematic – algorithmic funds based on returns correlation. We have decided to share a few graphs with you.
Graphs clearly show that large algorithmic funds are more likely to have correlated returns with each other than smaller ones. Typically, it is caused by liquidity problem. A smaller algorithmic fund is more flexible and can exploit wider range of trading strategies than a large one. Take for example Winton Capital Management algorithmic fund which manages 12.3 billion dollars of assets. It is hard to imagine how such a large fund would trade at night session when liquidity decreases considerably. It would also be difficult for a such fund to trade in higher frequencies. Therefore, large funds usually try to catch larger market trends and hold investments longer. This leads to similar and more correlated returns of large funds.
Meanwhile, small funds which manages from a few to tens of millions can trade in high frequency, at night time and trade less liquid financial instruments. Small funds are much less likely to correlate both with small and large funds. Thus, such funds are more suitable for the investment portfolio.
It is vital to perceive that financial markets are becoming more global than ever. They become highly dependent on each other, so if one falls, then usually so does the others. Consequently, it becomes increasingly difficult to find investments which would have a low correlation with other investments. Our advice to any investor is simple – make a wider diversification by mixing a variety of investments with as low correlation to each other as possible. Then the risk will be low.