Factors: Correlation Check

Watch Out for High Correlations?

September 2017. Reading Time: 10 Minutes. Author: Nicolas Rabener.


  • Correlations between Quality and Growth factors are currently elevated
  • Value is more negatively correlated than usual to Quality, Growth and Low Volatility
  • Monitoring correlations is important for maximising diversification benefits


The rise of ETFs is often associated with higher stock correlations, which are not desirable from a fund manager’s perspective as they make alpha generation more challenging. However, despite the passive money management industry having significant inflows in 2017 and the market share reaching an all-time high, stock correlations are at multi-year lows. In factor investing correlations play a large role in the factor allocation process and it’s interesting to see if low stock correlations reflect in low factor correlations. In this short research note we will analyse current and historical factor correlations and the impact on portfolio construction (read Smart Beta vs Factors in Portfolio Construction).


We’re going to focus on the six well-known factors: Value, Size, Momentum, Low Volatility, Quality and Growth and the global time series, which aggregates the factor performance of Asia, Europe, and the US. The factors are constructed as beta-neutral long-short portfolios by taking the top and bottom 10% of the stock universes in the US, Europe and Japan and 20% for markets with smaller stock universes. Only companies with a minimum market capitalization of $1bn are considered and 10bps of transaction costs are included (try Finominal’s Alpha Analyzer for a factor exposure analysis).


The matrix below shows the correlations for the factors over the last year. We highlighted any correlations larger than 0.5 in red and any smaller than -0.5 in green. We can observe that only the Quality and Growth factors are highly correlated and that Value shows strong negative correlations with Momentum, Quality, and Growth. High correlations are less desirable for portfolio construction as the diversification benefits are lower than with low o