Can any of the company-specific risk be diversified away by investing in both Franklin and B of A at the same time? Although using a correlation coefficient on its own may not help to predict future stock returns, this module helps to understand the diversifiable risk of combining Franklin and B of A into the same portfolio, which is an essential part of the fundamental portfolio management process.
By analyzing existing cross correlation between Franklin K2 Alternative and Bank Of America, you can compare the effects of market volatilities on Franklin and B of A and check how they will diversify away market risk if combined in the same portfolio for a given time horizon. You can also utilize pair trading strategies of matching a long position in Franklin with a short position of B of A. Check out your portfolio center. Please also check ongoing floating volatility patterns of Franklin and B of A.
Diversification Opportunities for Franklin and B of A
The 3 months correlation between Franklin and BAC is 0.56. Overlapping area represents the amount of risk that can be diversified away by holding FRANKLIN K2 ALTERNATIVE and Bank Of America in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Bank Of America and Franklin is a relative statistical measure of the degree to which these equity instruments tend to move together. The correlation coefficient measures the extent to which returns on Franklin K2 Alternative are associated (or correlated) with B of A. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of Bank Of America has no effect on the direction of Franklin i.e., Franklin and B of A go up and down completely randomly.
Assuming the 90 days horizon Franklin is expected to generate 8.35 times less return on investment than B of A. But when comparing it to its historical volatility, Franklin K2 Alternative is 13.35 times less risky than B of A. It trades about 0.41 of its potential returns per unit of risk. Bank Of America is currently generating about 0.26 of returns per unit of risk over similar time horizon. If you would invest 2,811 in Bank Of America on September 7, 2023 and sell it today you would earn a total of 242.00 from holding Bank Of America or generate 8.61% return on investment over 90 days.
Over the last 90 days Franklin K2 Alternative has generated negative risk-adjusted returns adding no value to fund investors. In spite of fairly strong basic indicators, Franklin is not utilizing all of its potentials. The current stock price disturbance, may contribute to short-term losses for the investors.
Compared to the overall equity markets, risk-adjusted returns on investments in Bank Of America are ranked lower than 7 (%) of all global equities and portfolios over the last 90 days. In spite of rather unsteady basic indicators, B of A may actually be approaching a critical reversion point that can send shares even higher in January 2024.
The main advantage of trading using opposite Franklin and B of A positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if Franklin position performs unexpectedly, B of A can make up some of the losses. Pair trading also minimizes risk from directional movements in the market. For example, if an entire industry or sector drops because of unexpected headlines, the short position in B of A will offset losses from the drop in B of A's long position.
The idea behind Franklin K2 Alternative and Bank Of America pairs trading is to make the combined position market-neutral, meaning the overall market's direction will not affect its win or loss (or potential downside or upside). This can be achieved by designing a pairs trade with two highly correlated stocks or equities that operate in a similar space or sector, making it possible to obtain profits through simple and relatively low-risk investment.
Check out your portfolio center.Note that this page's information should be used as a complementary analysis to find the right mix of equity instruments to add to your existing portfolios or create a brand new portfolio. You can also try the Equity Valuation module to check real value of public entities based on technical and fundamental data.
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