Tag Archives: correlation

How to understand the figures of my portfolio to obtain better results? (II)

We have already written about some relevant figures to manage your portfolio, as the performance evolution, the weight of the assets and the relationship between performance and volatility. There are three other parameters to take into account for your portfolio. They are related to the diversification of the portfolio assets.

It is always said that diversification limits risks and helps avoid high losses. It depends on how it is considered. For instance, you can have several assets, but it does not mean that the whole portfolio is diversified. On the contrary, it can have a low diversification, if the assets are very correlated. In this case, a movement in one of your securities has effects in the others.

Another relevant item to obtain from your portfolio is the risk contribution. These figures explain the proportion of each security to the whole risk of your portfolio. This analysis helps take decisions, as selling a share or a fund if the risk is high related to the performance that it provides to the whole investment.

Risk contribution in a T-Advisor portfolio

In the chart above, it is possible to see the different risk contribution of each share to a specific portfolio focused in Germany. If we compare this chart with the weight of each asset, IWKA is the largest, following by Dialog Semicon. However, both have provided the highest unrealised gains (59% and 46%, respectively). On the contrary, BB Biotech AG has unrealised losses of 78.5%, but the weight is 1.83% of the portfolio. That is why its risk contribution is so low.

Finally, the last measure about diversification is diversification benefit. We have already commented about it, but it is interesting to connect this figure with others to analyse the portfolio. Diversification benefit quantifies how much you earn or how much you avoid losing if you diversify your investments.

Diversification benefit in T-Advisor

As the table shows, a diversified investment protects against higher risks, if the investment cycle is negative for you. In this case, the investor is avoiding losing a 24% more.

In T-Advisor, you can also check your diversification in the “follow up” tab of your portfolio report.

diversification follow up in T-Advisor

As you can see in both articles, it is necessary to analyse your investments from different points of view and connecting different figures to understand the quality of your portfolio. If you do not understand some of these figures, you will have to deal with troubles for your money.

Comparing my assets with its benchmark: some figures for analysis

Comparative figures asset benchmark

As investors, we look for the best performance. A good performance is not only an absolute figure, but also a relative one, when we make comparisons. For instance, if a share in our portfolio has a performance of 10% in a year, we can think that it is a nice number, in absolute terms. But if the reference index of the share has performed a 15%… well, it is not so nice. That is why it is interesting to take into account some figures to understand if our securities have a good quality compared with their benchmarks:

  • Relative trend of the security versus index: it compares both behaviours. If the figure is positive, the security is strong versus the index. If it is negative, there is a weakness. It is one sign to detect if our stock or fund is performing properly against the index.
  • Tracking error: this indicator measures the deviation of the difference in daily returns of the security and the benchmark. A higher figures shows that the daily returns of the security has a larger difference compared with the daily returns of the index.
  • R 2: it measures the similarity of the daily behaviour of both the asset and the index. If the figure is near to 1, there is a strong parallelism. If it is near 0, there is no relation.
  • Correlation: if R 2 measures the similarity of the behaviour, this provides more specific information. If the figure is near to 1, there is a positive correlation (both move identically in the same trend). If it is near to -1, the correlation is negative (both move identically in opposite trends). If it is near to 0, there is no correlation.

R 2 and correlation are very important to find assets not linked with the benchmark if its evolution is negative, for instance, when the index drops. On the other hand, it is also interesting to find correlated assets when the index soars.

  • Alpha and beta: both are quite important to measure the outperformance and volatility of the asset compared with the benchmark. We have an extended explanation in this post. Typical investor behaviour is looking for assets with good alpha.

Of course, the analysis of a single reference is not enough to get an idea about the relationship between the asset and the index. We have to look at all data and connect them to understand in a right way if we should put our money there or just go our quickly.

Ideas to survive with your investments in political risky times

Investments: bearish against bullish

The current year has been commented several times as a year in which political risks will play a role: Brexit, Trump, elections in France and Germany, amongst others. We usually think in other kind of risks when we speak about investments, but in this case it is possible that we have to consider the political factor.

Anyway, we want to obtain the best returns with the lower risk. How could you move your assets in 2017 with this scenario?

First of all, check yourself. No, we do not speak about your health, but about your financial needs and plans. Do your budget, organise a cash flow, analyse your expenditures and think about your financial goals.

Secondly, analyse quietly your portfolio. Is it correctly diversified? Have you recently checked the evolution and consider a rebalance? It is important to take into account that diversification is not a matter of number of securities or different kind of them (equities, fixed-income…). It has more to do with avoiding correlations and considering factors. What does factor here mean? Think about that you have different kind of securities from UK. If all your investments are connected with this country, you have the Brexit factor and this political issue will condition the returns. That needs a wide view over the reality.

Thirdly, in order to choose the best assets for your portfolio in uncertain times, remember to check some figures, as:

  • Trading volume and liquidity: it is very relevant that the asset has a high trade rate and it is easy to sell, in order to avoid counterparty risks.
  • Volatility: the higher it is, the higher is the risk that you have to deal with deep price changes.
  • Past performance and bootstrapping: it is true that past returns do not guarantee future ones, but an analysis of the past trend combined with a forward testing with a bootstrapping tool can be helpful to select better securities for your portfolio.
  • Correlation with its benchmark: this is quite important, even more if the market is risky.

Finally, the main rule for investors in uncertain times (as we are living now) is common sense. Invest only the money left, not the amount to pay your mortgage, think about how regular and safe are your incomes and be reasonable with your goals.

Investment risk: some figures to watch in the assets

Risk chapter in a T-Report in T-Advisor

When you are an investor, you accept some risk. We have already written about the different kind of risks in investments. The question is: can we measure the risk? Well, risk is a qualitative ratio, but we can obtain some clues through quantitative measures.

Volatility is one of these measures. Does it mean that high volatility is the same as high risk? It depends on the asset. First of all, volatility does not measure the risk, but the price variation in a certain period. If there is a high diversion from the average price, it is very volatile. Of course, it is risky, as far as the prices change sharply and the investor can win or lose suddenly. However, think about another asset, as housing. Prices are no so volatile, but it is risky, because you have another risks: counterparty risk, inflation risk…

The liquidity grade is also important to measure the risk, as an investor can perceive how often the asset is purchased or sold. A low liquidity shows that the asset has a high risk that you cannot find a buyer when you want to sell it.

One of the most important measures for risk is Value at Risk, broadly know by its initials VaR. This index shows how much an investor can lose at the most with a probability of 95% in a certain period. The higher is the figures, the more risky is to lose money.

Correlation offers also a clue about the risk. This figure has a range between -1 and 1. In this case, the asset is compared with another asset, with its sector or with the reference stock index. If the correlation is 0 or near to 0, there is no correlation. If is 1 or near 1, there is a high correlation: the asset moves following the trend of the reference. On the other side, if is -1 or near -1, there is an inverse correlation: the asset moves in the opposite trend of the reference. This is very useful for negative waves, for instance.

As you can see, risk has no concrete measure. You have to look into figures to discover if the asset is risky and if the risk level of the asset is acceptable for your profile. The T-Report in T-Advisor gives full details about all the data about risks that an investor need to know to take decisions.

Alpha and beta: Greeks in my portfolio

Two main concepts in the modern portfolio theory are the alpha and beta measures. They give the investor some information about the asset (a share, a fund, an ETF, for instance) risk compared with its benchmark, but both are quite different.

alpha y beta in T-Advisor

f we take our T-Advisor screen and choose an asset (for this case, Vestas Wind System), the T-Report from it has a chapter titled “Relative performance vs index”. We already wrote about  correlation. Now, let’s explain what alpha and beta are and why they are important references for investors.

Alpha shows the outperformance of the asset compared to its benchmark for an assumed risk. In the picture, the figure is 0.0197. That means: this asset performs better than the reference index. The higher, the better. This additional performance has to do with other reasons not linked with the benchmark. This measure appears also for funds and portfolios. A way to discover if the fund manager is good is just looking the alpha.

What about beta? In this case, this figure measures the volatility or how much the asset varies in its price when the benchmark moves up or down 1%. If it is positive, the asset varies in the same direction as the benchmark. If it is negative, the variation is the opposite.

For instance, in the example above, beta is 1.27. This means that the asset is more volatile than the index: when the index changes 1%, the asset does 1.27%. If the ratio would be less than 1, that means that the asset has a low volatility.

This is the theory, but what about the practice? Just remember some ideas:

  1. Look for positives alphas but beware the beta together, because beta points how much risk you are accepting.
  2. For bullish markets, look for assets with high positive betas.
  3. On the contrary, for bearish markets, choose low or negatives betas. In this last case, the correlation is inverse.

In all cases, the investor is choosing the risk exposure. T-Advisor provides the figures. How much you are exposed is a question of your own decision.

Danger: correlated assets

Correlation is a statistical concept. It shows the relationship between two variables. In our case, it measures if two or more assets move in the same direction when one of them changes. For instance, if you have two companies from the oil sector in your portfolio, it is very possible that both increase their prices at the same time, if the oil barrel is more expensive.

However, it is difficult to detect for many investors. Very correlated assets in the portfolio increase the risks of losing money. It is similar to put all the eggs in the same nest. But there are some helps to avoid these risks. The first one is the correlation ratio. It varies between -1 and 1. If the figure is near to 1, there is a high correlation. If it is near to -1, there is an inverse correlation (when the price of one asset changes, the other changes in the opposite way). If it is near to 0, there is no correlation.

Portfolio with figures of correlation in T-Advisor

The assets in the picture have a high correlation. This portfolio is very risky. A defensive proposal would look for non-correlated assets or even with inverse correlated.

A second hint to detect correlations is diversification. It is important to have a good asset allocation. VaR also provides some clues, over all if you have the “Diversification benefit” tool. We have already published a post about it.

Diversification benefit and portfolio risk charts in T-Advisor

T-Advisor has also a tool that measures the portfolio diversification and suggests changes to reduce the risks.

Diversification ratio in T-Advisor

Last idea to discover correlations and take decisions to avoid it is the portfolio optimization. T-Advisor has the tool “Optimizer” to find correlated and non-correlated assets. The tool recommends positions to be reduced or enlarged. So, the investor has the chance to improve the risk and performance.

Optimization portfolio in T-Advisor

To sum up, correlation is a measure about our portfolio risks and our diversification. A high correlation is always a warning signal, because it is possible that you get a positive trend in a period, but… what about if the trend is negative?

Portfolio optimizer: a tool to improve your investments

Investors organise efficiently their portfolios to obtain the highest returns, but a portfolio has to be followed up, because some adjustments are sometimes necessary. The problem is how to detect the best changes to get the profit goals. That is why T-Advisor developed the tool “Optimizer” for this target.

Optimizer T-Advisor

In the Optimizer, the investor can choose the expected return and volatility depending the term (shorter or longer), as the percentage of acceptable volatility and the weight limits per assets. Clicking on the “optimize” button brings the results.

From the beginning point and the chosen settings, the tool calculates different parameters. The efficient frontier is a visual comparison between the current position and the optimal one, linking volatility and performance. The investor can also learn which assets should be changed in their weight to optimize the returns.

At the end, investors have a helpful tool to adjust their portfolio and adapt their assets to the changing market. What are the main advantages of this tool? Well, first of all, it lets combine different risk limits (volatilities) with different terms of expected returns. The result is that the investor can choose amongst different possibilities depending his or her interests or circumstances.

Secondly, it is helpful to discover correlated and non-correlated assets. With this information, the investor can reduce the risks and maximize the returns. Moreover, the tool lets the investor decide about which positions should be enlarged and which should be reduced to obtain the targeted performance.

To sum up, T-Advisor Optimizer is an easy visual tool that reports the investor about the changes to be done in the portfolio to get the best results. The main advantage is that the tool has different settings available so that the investor can choose which one fix to their particular requirements: the freedom in one click.