Measuring portfolio performance while doing portfolio monitoring involves risk and return analyses – the two primary measures to gauge an investment’s progress over time. Ideally, the returns should be bigger, and the risks should be smaller. Let’s explore the five key metrics that experts offering portfolio monitoring solutions use to measure a fund or portfolio’s performance.
- Standard Deviation
Standard Deviation is the degree to which an individual value varies from the mean distribution. Expressed in percentage, it portrays a portfolio’s volatility and helps make forecasts based on the trends identified. Securities with higher standard deviations will undergo more significant value swings in both directions than securities with lower standard deviations and predictable price swings.
The Beta metric represents how a security’s returns are sensitive to value swings in the market. Similar to Standard Deviation, the Beta metric also gives investors an idea of how volatile a portfolio or fund is. Besides that, Beta also provides additional information concerning the portfolio’s movements in relation to the selected benchmark.
The alpha metric represents the value a portfolio or investment fund manager adds based on the portfolio’s risk-adjusted performance. It quantifies a portfolio or fund manager’s ability to provide risk-adjusted returns with respect to the benchmark. Alpha, also known as the active return, is expressed in percentage. A positive alpha figure depicts outperformance, while a negative alpha figure depicts underperformance.
- Sharpe Ratio
Nobel laureate William F. Sharpe developed this ratio to measure an investment’s risk-adjusted performance. Experts in portfolio monitoring solutions calculate the Sharpe ratio by subtracting the risk-free rate from the return rate for a portfolio. Then they divide the result by the portfolio returns’ standard deviation. This key metric indicates an investor’s reward after taking additional investment risk.
The R-Squared metric measures how much price movements of a portfolio or fund can be attributed to broader market movements as indicated by the benchmark. The R-Squared value ranges from 0 to 1 and is commonly presented in 0 to 100 percentage points. For instance, an R-Squared of 100% indicates all security movements are attributed to the index movements. A high R-Squared of 85 to 100% suggests that a portfolio’s performance relatively moves in relation to the index. An R-Squared of 70% or less indicates that security generally does not follow the index movements.
Other Crucial Metrics
- Total Return: Calculating the total return is ideal for measuring an investment’s overall returns. It includes capital gains, distributions, and dividends compared to a benchmark.
- Time Horizon: Investors have to choose a time horizon based on their investment style and goals. Examples include long-term growth, capital preservation, current income, savings, etc.
- Monitoring Frequency: The most common frequency for portfolio monitoring is every three months since monitoring the metrics periodically is of the essence.
Apart from these metrics, there are more ways to measure portfolio performance. Selecting appropriate metrics is crucial to measuring portfolio risks and returns. They help examine a portfolio’s performance and let an investor leverage the most critical portfolio monitoring solutions. With this understanding, they can gauge why an investment performed in a particular way and accordingly plan their future investments.