What is ‘R-Squared’
R-squared is a statistical measure that represents the percentage of a fund or security’s movements that can be explained by movements in a benchmark index. For example, an R-squared for a fixed-income security versus the Barclays Aggregate Index identifies the security’s proportion of variance that is predictable from the variance of the Barclays Aggregate Index. The same can be applied to an equity security versus the Standard and Poor’s 500 or any other relevant index.
R-squared values range from 0 to 1 and are commonly stated as percentages from 0 to 100%. An R-squared of 100% means all movements of a security are completely explained by movements in the index. A high R-squared, between 85% and 100%, indicates the fund’s performance patterns have been in line with the index. A fund with a low R-squared, at 70% or less, indicates the security does not act much like the index. A higher R-squared value indicates a more useful beta figure. For example, if a fund has an R-squared value of close to 100% but has a beta below 1, it is most likely offering higher risk-adjusted returns.
R-Squared Calculation Example
The calculation of R-squared requires several steps. First, assume the following set of (x, y) data points: (3, 40), (10, 35), (11, 30), (15, 32), (22, 19), (22, 26), (23, 24), (28, 22), (28, 18) and (35, 6).
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