Definition
R-squared (coefficient of determination) measures the percentage of a portfolio's returns that can be explained by movements in its benchmark index. Values range from 0 to 100. An R-squared of 100 means the portfolio moves exactly with its benchmark. A low R-squared indicates the portfolio's returns are largely independent of the benchmark. R-squared is useful for determining if beta and alpha are meaningful - these metrics are unreliable if R-squared is low.
Formula
Example
An S&P 500 index fund has R-squared near 100. A hedge fund with R-squared of 30 has returns mostly independent of the market, making its beta less meaningful for risk assessment.
FAQ
What is R-Squared?
A statistical measure of how much a fund's movements can be explained by benchmark movements.
How do you calculate R-Squared?
A common formula for R-Squared is: R² = (Correlation)²
Why is R-Squared important?
R-Squared helps investors evaluate portfolio management and make more informed decisions.
Related Terms
Alpha
The excess return of an investment relative to a benchmark index.
Beta
A measure of a stock's volatility relative to the overall market.
Correlation
A statistical measure of how two investments move in relation to each other.
Tracking Error
The standard deviation of differences between portfolio and benchmark returns.