Investing involves putting your money into something –  a stock, a bond, a piece of real estate – with the intention of earning a positive return.  With the industry-wide implementation of the Client Relationship Model II, also known as CRM2, investors now have greater disclosure and transparency into their investments so that they can better assess whether their portfolio is in line with – and progressing towards – their financial objectives.

This is a very positive development that helps re-establish trust between the investment industry and investors. What I feel is missing from the broader conversation about client transparency, however, is the inclusion of metrics on how well portfolios manage risk to generate their returns.  The returns of most investment asset classes (stocks, bonds, and real estate) are generally positively correlated with risk: the higher the risk of an investment, the higher the expected return (I would posit that education is the only low risk/high return investment).  But how does an investor go about measuring the risk of their portfolio?  Here are some of the metrics I look at:

  • Volatility, as measured by annualized standard deviation over a minimum 36-month period. Standard deviation is a measure of the average deviations of a return series from its mean.  A large standard deviation implies that there have been large swings or volatility in a portfolio or strategy’s returns.
  • Maximum Drawdown measures the maximum peak to trough decline, or the loss from the highest portfolio value to its lowest point over a specific period, ideally since portfolio or strategy inception.
  • Upside Capture is a measure of a strategy’s performance in up markets relative to its underlying benchmark. It is a measure of correlation where a ratio of 150%, for example, means that the portfolio moves up 1.5% for every 1% move up by the benchmark.
  • Downside Capture is a measure of a strategy’s performance in down markets relative to its underlying benchmark. A ratio of 75%, for example, means that the portfolio moves down 0.75% for every 1% move down by the benchmark, thus protecting on the downside.  A negative downside capture ratio implies that during down periods, a strategy generates positive returns – a highly sought-after and desirable trait.

The metrics presented above are the ones I like due to their simplicity and the insight they provide, though they are certainly not exhaustive.  Data can inform or mislead, and for metrics to be meaningful, they need to relate back to and be considered within the proper context, including the time period of study (longer is generally better), whether the same metrics for the benchmark or market over the same time period are being used (for relative comparison), and the nature of the investment (publicly traded equities versus private equity, for example).

While portfolio returns are certainly a key metric for any investor, the above metrics can help you discern if your portfolio is adding value without taking on undue risk.  Our team at MCA Cross Border Advisors can consult with you to provide an independent review and analysis of your investment portfolio to determine whether gaps and opportunities exist to enhance your return and/or reduce your risk.

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MCA Cross Border Advisors, Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.