R-Squared

The r-squared measure is an indication of how closely correlated a fund is to an index or a benchmark. It can be treated as a percentage, showing the proportion of a fund’s movements that can be attributed to those of the benchmark. Values for an r-squared measurement range between 0 and 1, with 0 indicating no correlation at all and 1, rarely, showing a perfect match. Values upward of 0.7 suggest that the fund’s behavior is increasingly closely linked to its benchmark, whereas the relevance diminishes as the r-squared measurement descends toward 0.5 and starts to disappear altogether below 0.5. 15 R-squared is a key ratio, in that other measures of a fund’s performance — such as alpha and beta — will have been calculated by reference to its benchmark. The weaker the r-squared correlation, the more unsuitable the benchmark is and the more unreliable these measures will be in assessing the fund.

The calculation may be explained as such:

 

The values for r-squared can be considered as percentages. For example, an r-squared of 0.81 implies that 81% of the data points sit on the regression line, thus 81% of the data points match perfectly over the period under analysis.