Portfolio Analysis  What is the Portfolio Analysis?

Portfolio Analysis is one of the areas of investment management that enables market participants to analyze and assess the performance of a portfolio (equities, bonds, alternative investments etc) with the objective of measuring performance on a relative and absolute basis along with its associated risks.

Tools Used in Portfolio Analysis

Some of the top ratios used are as follows –

1) Holding Period Return

It calculates the overall return during the investment holding period

2) Arithmetic Mean

It calculates the average returns of the overall portfolio

= (R1 + R2 + R3 +……+ Rn) / n

R – Returns of Individual Assets

3) Sharpe Ratio

It calculates the excess return over and above the risk free return per unit of portfolio risk

= (Expected Return – Risk-Free rate of return) / Standard Deviation (Volatility)

4) Alpha

It calculates the difference between the actual portfolio returns and the expected returns

= Actual rate of return of portfolio – Expected Rate of Return on Portfolio

5) Tracking Error

It calculates the standard deviation of the excess return with respect to the benchmark rate of return

= Rp-Rb

Rp = Return of Portfolio, Rb – Return on Benchmark

6) Information Ratio

It calculates the success of active investment manager strategy by calculating excess returns and dividing it by tracking error

= (Rp – Rb) / Tracking error

Rp = Return of Portfolio, Rb – Return on Benchmark

7) Sortino Ratio

It calculates the excess return over and above the risk-free return per unit of negative asset returns

= (Rp – Rf) / σd

Rp = Return of Portfolio, Rf – Risk-Free Rate, σd = standard deviation of negative asset returns

For eg:
Source: Portfolio Analysis (wallstreetmojo.com)

Examples of Portfolio Analysis

Let’s understand this concept in more detail with the help of a few examples by making use of these popular tools as discussed.

You can download this Portfolio Analysis Excel Template here – Portfolio Analysis Excel Template

Example #1

Ryan invested in a portfolio of stocks as discussed below. Based on the information, calculate the holding period return of the portfolio:

Holding Period Return={(Ending Value–Beginning Value)+Dividends Received}/Beginning Value

Below is the use holding period return formula.

Example #2

• Venus investment is trying to undertake a portfolio analysis of one of its funds namely growth 500 using certain performance measures. The fund has an information ratio of 0.2 and an active risk of 9%. The funds are benchmarked against the S&P 500 and have a Sharpe ratio of 0.4 with a standard deviation of 12%.
• Venus investment has decided to create a new portfolio by combining growth 500 and the benchmark S&P 500. The criteria are to ensure a Sharpe ratio of 0.35 or more as part of analysis. Venus has decided to undertake the portfolio analysis of the newly created portfolio using the following risk measure:

Sharpe Ratio

Optimal Active Risk of the New Portfolio = (Information Ratio/Sharpe Ratio)*Standard Deviation of Benchmark S&P 500

Accordingly Sharpe Ratio of the New Portfolio = (Information Ratio ^2 + Sharpe Ratio ^2)

Thus the sharpe ratio is less than 0.35 and venus can not make an investment in the said fund.

Example #3

Raven investments are trying to analyze the portfolio performance of two of its fund managers Mr. A and Mr. B.

Raven investment is undertaking the portfolio analysis using the information ratio of the two fund managers with a higher information ratio act as a measure of superior performance.

The following details enumerated below are used to measure the information ratio for portfolio analysis purpose:

With a higher information ratio fund manager B has delivered superior performance.

Steps to Portfolio Analysis

• #1 – Understanding Investor Expectation and Market Characteristics – The first step before portfolio analysis is to bring in sync the investor expectation and the market in which such Assets will be invested. Proper sync of the expectations of the investor vis-à-vis the risk and return and the market factors helps a long way in meeting the portfolio objective.
• #2 – Defining an Asset Allocation and Deployment Strategy – This is a scientific process with subjective biases and it is imperative to define what type of assets the portfolio will invest what tools will be used in analyzing the portfolio, which type of benchmark the portfolio will be compared with, the frequency of such performance measurement and so on.
• #3 – Evaluating Performance and Making Changes if Required – After a stated period as defined in the previous step portfolio performance will be analyzed and evaluated to determine whether the portfolio attained stated objectives and the remedial actions, if any, required. Also, any changes in the investor objectives are also incorporated to ensure portfolio analysis is up to date and keeps the investor expectation in check.

For eg:
Source: Portfolio Analysis (wallstreetmojo.com)