Investment portfolio review is crucial for evaluating the performance and risk of your investments. A proper review helps identify issues and improve your portfolio allocation. This article will provide key information and conclusions on reviewing investment portfolios from aspects of return, risk and optimization. Proper portfolio review requires analyzing return, risk-adjusted return, diversification, drawdowns, fees and taxes. Optimization can be achieved through rebalancing, adding new assets or strategies, and adjusting your portfolio to target the efficient frontier. With hundreds of factors and anomalies discovered, utilizing factors in stock selection and asset allocation is also effective. Overall, a systematic portfolio review framework allows investors to maximize returns, control risk, and build robust portfolios.
Use total return, risk-adjusted return metrics to evaluate portfolio performance
The total return measures the simple raw return generated by the portfolio over a period. But return alone does not indicate how much risk is taken to achieve it. Risk-adjusted return metrics like Sharpe Ratio and information ratio incorporate risk factors. The higher the risk-adjusted return, the more reward obtained per unit of risk taken. These metrics enable comparison between portfolios and benchmarks on an equal risk footing. The Treynor ratio focuses on systemic risk measured by beta while the Sharpe ratio considers total volatility. The information ratio compares active return to tracking error volatility. Other useful metrics include alpha, upside/downside capture ratios and appraisal ratio.
Examine portfolio diversification and drawdowns
A well-diversified portfolio is key to managing risk and avoiding concentrated bets. Metrics like R-squared measure how diversified the portfolio is and whether it depends largely on certain factors. Analyzing drawdowns reveals how the portfolio performs in market downturns. The maximum drawdown shows the largest peak-to-trough decline. Average drawdown metrics give the typical declines expected. Smaller and fewer drawdowns indicate better resilience.
Consider the impact of fees, transaction costs and taxes
Investment fees and transaction costs directly reduce net returns. Portfolios with high turnover tend to have larger transaction costs. Taxes can also detract significantly from net gains in taxable accounts. After-tax returns should be evaluated to incorporate tax effects fully. Tax-efficient strategies like tax-loss harvesting and asset location can help manage the tax impact.
Rebalance and optimize portfolio towards the efficient frontier
As market conditions change, portfolios drift from target allocations. Rebalancing trades the portfolio back towards initial targets. Adding new negatively correlated assets can also improve diversification and risk-adjusted returns. Optimizing portfolios to target the efficient frontier allows maximizing return at each risk level. Utilizing factors with robust premiums in stock selection and asset allocation can enhance returns.
A systematic investment portfolio review framework incorporates both quantitative metrics and qualitative aspects for a holistic evaluation. This ultimately helps identify issues for improving portfolio construction and achieving investment objectives.