Correlation plays a key role in mutual fund portfolio diversification by helping reduce overall risk. When you invest in funds that don’t move in the same direction at the same time, it makes your portfolio more balanced. Low or negative correlation between funds means when one fund performs poorly, another may perform well, helping to stabilize returns.

What Does Correlation Mean in Mutual Funds?

In mutual funds, correlation refers to how two different funds or assets move in relation to each other. If two funds have high correlation, they tend to rise and fall together. If they have low or negative correlation, they move differently. Understanding this helps in building a more balanced and diversified investment portfolio.

Why Is Correlation Important in Diversification?

Correlation is important because it helps reduce portfolio risk. By combining mutual funds that behave differently, investors can avoid large losses if one fund performs poorly. This way, even if some investments drop in value, others might rise, balancing the overall returns and making your portfolio more stable.

How Does Low Correlation Improve Mutual Fund Portfolios?

Low correlation means two funds don’t move in the same direction. When added to a portfolio, they help reduce the impact of market ups and downs. For example, if one fund falls in value, another with low correlation may not be affected or could even rise, helping to protect your overall investment.

What Is an Example of Diversifying with Correlation?

Suppose you invest in a mutual fund focused on Indian equities and another in global bonds. These two funds likely have low correlation because they are affected by different markets. When Indian stocks fall, global bonds might perform better. This combination helps keep your investment stable and diversified.

How to Find Correlation Between Mutual Funds?

You can find correlation by checking historical performance data of two funds. Many financial websites and tools offer correlation calculators. A value close to +1 means high correlation, 0 means no correlation, and -1 means negative correlation. Choosing funds with lower correlation improves diversification and reduces risk.

Can Correlation Change Over Time?

Yes, correlation between mutual funds can change due to market conditions, economic changes, or sector performance. A pair of funds that once had low correlation may become more aligned during a global crisis. That’s why it’s important to review your portfolio regularly and adjust your investments as needed.