Risk Metrics - A Quick Guide

It’s important to identify which types of statistics will be the best at helping your Firm inform potential clients as to what are the basics of your investment strategy. Every strategy differs in terms of its investment objective and choosing the right risk metrics is crucial in understanding the investment goals and objectives.

Think through what makes your strategy unique and always consider the prospective client target audience.

• Alpha - Measures a portfolio’s risk-adjusted performance against that of its benchmark

  ■ A positive alpha indicates relative outperformance

  ■ A negative alpha indicates relative underperformance

• Beta - Measures the volatility of a security or portfolio to market movements

  ■ A beta less than 1.0 indicates likely lower volatility than the market

  ■ A beta greater than 1.0 indicates likely higher volatility than the market

• Capture Ratio - Measures the percentage of benchmark return captured by a portfolio manager during a specified period

  ■ Upside capture: A ratio greater than one indicates that the portfolio outperforms in up markets

  ■ Downside capture: A ratio less than one, even negative, indicates that the portfolio outperforms in down markets

• Correlation - Measures how a portfolio’s asset classes move in relation to each other in response to market events

  ■ Correlation ranges from +1 to -1. The closer two assets are to a +1 correlation, the more likely they are to move in the same direction

  ■ A negative correlation indicates two assets moving in opposite directions

  ■ Low or negative correlation among assets within a portfolio may help reduce overall portfolio volatility

• Information Ratio - Measures the consistency of a portfolio manager’s performance versus the benchmark

  ■ A higher, positive information ratio indicates the manager has beaten the benchmark without taking excessive risks

• R2 (R-squared) - That part of a portfolio’s volatility that can be explained by movements in its benchmark or market

  ■ An R2 of 100% shows that all movements of a portfolio are completely explained by movements in the benchmark or market

  ■ A low R2 indicates that little of the portfolio’s movement can be explained by benchmark or market movements

• Sharpe Ratio - Measures the reward-to-risk efficiency of a portfolio

  ■ The higher the Sharpe ratio, the better the portfolio’s historical risk-adjusted performance

• Standard Deviation - A common statistical measure of portfolio volatility

  ■ Standard deviation measures how much a portfolio’s total return varies from its mean or average

  ■ The more a portfolio’s returns fluctuate from month to month, the higher its standard deviation and the greater its volatility

• Tracking Error - Measures the volatility of a portfolio’s excess return versus its benchmark

  ■ An actively managed portfolio typically has a high tracking error

  ■ An index fund is expected to have a tracking error close to zero