Portfolio performance evaluation is the process of measuring and analyzing the returns generated by an investment portfolio over a certain period of time. The goal is to assess the effectiveness of the portfolio's management and make any necessary changes to improve its performance.
To evaluate a portfolio's performance, various metrics can be used, including:
Total return: The total return of a portfolio is the combination of capital appreciation and income (dividends, interest, etc.) received over a given period.
Risk-adjusted return: The risk-adjusted return of a portfolio measures its returns relative to the amount of risk taken to achieve those returns. This is usually measured using metrics such as the Sharpe ratio or the Sortino ratio.
Volatility: Volatility measures the fluctuations in the value of the portfolio over time. A low volatility indicates a more stable portfolio, while a high volatility indicates a more unpredictable portfolio.
Diversification: Diversification measures the extent to which a portfolio is spread out among different asset classes and individual investments. The goal is to reduce overall risk by having a mix of investments with different risk and return characteristics.
Example:
Suppose we have a portfolio with a total value of $1 million consisting of 60% equities, 25% bonds, and 15% cash. We'll evaluate its performance over the past 5 years, from January 1, 2018 to December 31, 2022.
Total return: The portfolio generated a total return of 11.5% per year over the 5-year period, with an average return of 2.3% per year.
Risk-adjusted return: The Sharpe ratio of the portfolio was 0.85, indicating that the portfolio generated returns relative to the amount of risk taken.
Volatility: The portfolio's standard deviation was 9.6%, indicating moderate volatility in the portfolio's value over the 5-year period.
Diversification: The portfolio had a good mix of different asset classes, with equities making up the largest portion, bonds making up a moderate portion, and cash making up a small portion. This diversification helped to reduce overall portfolio risk.
Overall, the portfolio performed well over the 5-year period, with a good total return and risk-adjusted return. The portfolio's diversification helped to reduce risk and ensure stability over the long term.
