Four Key Risk Assessment Metrics

In times of ongoing high market volatility and crisis, investors and portfolio managers face the challenging task of assessing investment-related risks and possible returns. The timing could not be more appropriate for us to share with you what portfolio risk indicators to watch for to target the most stable and predictable return on your portfolio.

Many investors use the return on investment (ROI) as the main criteria for choosing the investment product to spend the money on. They compare the return on stocks vs. return on bonds, returns on large caps vs return on small caps companies, examine companies’ analytical reports to identify the ones with the most growth potential, and sometimes even browse through social network ads promising tens of thousands of percent of return on some crypto assets. However, it is not only high ROI that makes for a smart investment but also an investment product’s ability to deliver stable returns over a period.

We would like to elaborate on a few, fundamental and easy-to-comprehend risk assessment indicators: standard deviation, downside deviation, Sharpe ratio, and Sortino ratio. Examining these risk assessment metrics along with a visual portfolio track record even inexperienced investors can get a clue when something is amiss with the portfolio performance.

We will start with the standard deviation. Portfolio standard deviation refers to the volatility of the portfolio that factors in the standard deviation of each of the assets allocated in the total portfolio, the respective weight of each asset in the total portfolio, and the correlation between each pair of assets of the portfolio. To put it simply, it tells investors how much the investment return will deviate from its expected return.

The indicator of portfolio standard deviation on its own is not informative. It becomes informative only when compared to other benchmark indicators such as S&P standard deviation, a portfolio strategy standard deviation, or the standard deviation of any other benchmark used by an investor. You can get an idea of how well a portfolio manager is doing his job of controlling risks by considering the standard deviation of the managed portfolio over a certain period, for example, several months.