Tag Archives: Diversification

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.

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

It sounds very nice when you think that you have your own investment portfolio. It is an important step to improve your finances and get your goals. The question is that a portfolio has its own life since its inception and your responsibility as investor is guiding the portfolio to your interests. What are the signals that you have to follow?

Well, there are many figures and parameters to measure the quality of your portfolio, but we will select the main ones in order to get the most important data:

  • The performance evolution: the figure alone is not enough, because it has to be put in comparison to others. We recommend comparing it with the smart benchmark. This comparison provides the view to understand if we have chosen the right assets or not. For instance, this example shows that we are far from the benchmark and there is a wide improvement to manage.

portfolio performance in T-Advisor

  • The weight of the assets in your portfolio: it is also relevant to understand the allocation. If we have a concentration in a country or a sector, there is a high risk to suffer from instability, if the trend changes. Diversification reduces risks, but we can have some assets with lower returns. A good analysis can help us look for similar assets with better figures in order to rebalance the portfolio.

weight of assets in a portfolio

  • The relationship between performance and volatility: first of all, volatility does not mean necessarily more risky, as we have already commented. However, we can understand the connection between performance and volatility through the Sharpe ratio. This figure shows how profitable an investment is related to the historical volatility. The higher the ratio is, the better the investment is… but this idea is not totally right if we do not compare two assets. You can find two assets with similar ratios but with different figures. We have to look into the numbers to understand if it has a high performance with a high volatility.

Portfolio sharpe ratio

There are some other figures that we will soon comment.

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.

What does portfolio optimisation mean?

Think about your portfolio. It does not perform as you would like and you do not know how to implement changes to improve the returns. Should you read all kind of reports? Of all possible assets? That’s nonsense. There should be a method to optimise and change efficiently your portfolio. There is actually and method: portfolio optimisation.

When we talk about it, it means the process of choosing the weights of different assets for your portfolio in order to obtain the best possible returns compared with similar portfolio compositions or risk profiles. The main measures taken into account are the expected returns and the expected volatility. Optimisation systems include limits of accepted volatility and weight per assets.

The system is linked to the Markowitz Efficient Frontier model that pretends to guide your investments maximizing your performances and reducing the risk. The main point that supports this model is choosing low-correlated or uncorrelated assets. Smart diversification is the idea behind it. An efficient portfolio means a well-diversified one.

Portfolio optimisation efficient frontier

Optimisation systems are professional tools to improve the portfolio results, but it has been implemented in T-Advisor for individuals. It is not easy, because you have to play with the following indicators:

  • Asset correlation
  • Maximum volatility
  • Expected return
  • Maximum weight per asset

The smart combination of the four indicators provides the success of the investment. They can change depending on your risk profile, but accepting a higher risk does not mean being suicidal.

Portfolio optimisation result charts

There is also another very important point: the costs. If you optimise your portfolio and follow the results of the optimiser tool, you have to rebalance your portfolio. A rebalance means trades to buy and sell in order to compose the portfolio following the optimisation indications and… it has costs. However, we have to remind that investments are for long-term and rebalances should be executed every certain time. In these cases, costs can be balanced out with the improvement of the returns. If you are a day trader, then forget this, because you are other kind of investor.

Risk and volatility: they are not really the same

risk and volatility in T-Advisor screener

We often read comments about the high volatility of any asset, as it would be a sign of a high risk. That is not necessary true, because you can find different assets with similar volatility and different returns: some positive and some negative.

Volatility reports about the variation of an asset price in a certain period or the deviation of its returns from the average. A high volatility suggests strong ups and downs in the asset price. That means for current investors that it is more risky, as they can lose money more quickly… but they can obtain also higher returns.

The question is that volatility is not a measure of risk taken as an only figure. It has to be linked with other measures. For instance, you have to watch the liquidity, because an illiquid asset is more risky, as it is more difficult to sell and obtain your money back.

Volatility also reports about the past, because it is the mirror where you find the information about what happened with the prices till today. You cannot obtain other information about risk. For instance, it does not report about the counterparty risk, let’s say, you invest in bonds and the issuer has no money to pay your coupon. To obtain those data, you have to look at other parameters.

The list of risk is long, but you cannot perceive them through the volatility. It is very important for investors to understand the difference, as many get good returns trading with the volatility of the asset. As we commented above, it can be an opportunity.

A relevant measure for the risk is the Value at Risk, also known for their initials VaR, but you have to watch also the diversification (in the case of a fund or your own portfolio), the correlation with other assets or the liquidity. To sum up, if you consider the volatility as the only way to control the asset risk, you will make a mistake. The risk analysis is a combination of several figures that have to be linked to obtain a global perception.

Is my portfolio working or not?

Portfolio main screen in T-Advisor

Investors organise efficiently their investments in portfolios. That’s the rule, but the question is: how to follow up my portfolio? Can I preview somehow troubles in my investments? Which ratios should I take into account to set and allocate my assets?

There are some indicators that give us some clues whether we are right or wrong and the changes we have to decide:

  • Returns: of course, this is the first one. As investor, you do not have to be anxious about the short term, because volatility is our current rule. You should use a tool that provides you different terms in order to compare the evolution. However, you have to think about changes if the returns are negative in the middle term.
  • Comparison with other references: it is a good idea to compare the evolution of your portfolio with the benchmarks (an index or a smart benchmark). This comparison will help you evaluate a proportion of the profits or losses that you get and diminish or underline the importance of the result. For instance, if your portfolio losses 3% and your benchmark losses 5%, it is not so bad. You are better than the index, although you should consider change your strategy, it the negative trend intensifies.
  • Diversification: get charts about the proportion of the assets in your portfolio related to regions, currencies and asset category. A diversified allocation will help you avoid several risks.
  • Risk: this is actually the second most important indicator after returns. Analyse the volatility, the value at risk (VaR) and the risk contribution of your positions. A segmented analysis will focus better your next decisions. Should I keep, sell or buy? Another quite important figure is the Sharpe ratio to understand how interesting is assuming risks in order to obtain certain returns.
  • Trend: you should as investor use tools to get the portfolio trend, if bullish or bearish.
  • Portfolio and investor profile consistency: is your portfolio consistent with your investment profile, your risk tolerance and your expected returns? That is another question that you have to ask yourself.

You need tools to make a full analysis and obtain a whole view over your portfolio and take the best decisions to improve your results. It is important that you get unbiased indicators, watch risk and returns, understand everything and take rational decisions, never guided by a short term situation. At the end, it is not only about profits, but above all capital preservation. The T-Advisor platform offers these figures so that everyone can set and allocate assets their own portfolios in the most efficient way.

My goal in bearish markets: capital preservation

Markets are currently very volatile. We have lived a strong bearish period, but it is not sure that the bulls are coming, as the trend is not clear yet. In this case, panic is the worst adviser. On the contrary, investors have to analyse properly their portfolios to take right decisions. If you are not a trader, if you are a long-term investor, then you have to assume that it is difficult to avoid losses in some periods, moreover when all markets are dropping. So, your goal has to be another: capital preservation.

What does capital preservation mean? Your goal as investor must be to keep your assets with the less possible losses or, of course, to obtain benefits. As there are many changes in the long term, then you have to concentrate your worries in the bearish times: how much are you losing? The success is not to lose or lose less than the reference markets, but how can you get that information? The answer is smart benchmark.

Smart benchmark chart in T-Advisor

The picture above is very clear: my portfolio is losing, because I have invested in a market that is going hard into negative, but I only lose -2.4%, while the reference market (the smart benchmark) loses -14%. Not bad, huh?

As we regularly say, it is important to have available the right tools to analyse your investments and take decisions. Capital preservation has to be your first goal. Don’t lose money or lose the least. Then it the bullish times, your goal has to be to outperform the reference market.

The following chart is even clearer:

Portfolio risk figures

My Germany portfolio is much better than the benchmark: quite less losses in a bear period, less volatility and better Sharpe ratio.

What other tools do I have to consider risks in order to preserve my capital?

  • Analyse how your positions contribute to risk your portfolio. In this case, you can find out if you have an uncomfortable asset to be substituted.

Risk contribution chart in T-Advisor

Risk profile comment with portfolio risk in T-Advisor

  • Consider the diversification. In bearish periods, diversification is a great help to avoid hard losses. You can analyse it with the diversification benefit, that compares how much you win if your portfolio has different assets:

Diversification benefit in T-Advisor

  • Look at the Value at Risk, which measures the probability of having a certain level of losses. As you can see, my portfolio has the worst VaR, what means that I have to consider some changes in my allocation to avoid future losses.

Portfolio risk table in T-Advisor

All these figures will help you to understand your current position and risk. Then you can decide if you have to rebalance totally or partially your portfolio. The strategy is clear: keep your capital and set your portfolio to lose less in bad times and outperform the benchmark in growing times.

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?

Diversification protects against risks

The title sentence sounds quite radical, but there is a truth behind these words. Usually, portfolios are composed by different kind of assets. Every analyst, every advisor always recommends a diversified portfolio with fixed income assets, stocks, commodities… But the question is: ok, everybody says that, but how much do I earn for the diversification.

The answer is simple: T-Advisor has the tool for it. Do you remember an older post about value at risk (VaR)? This measure shows the probability that your portfolio loses a maximum percentage in a period (week, month or year). To complete this information, T-Advisor has available a tool called “diversification benefit”.

Diversification benefit tool in T-Advisor

Look at the picture above. The item compares the difference between the decision of diversifying or not the portfolio. Through complex statistical calculations, T-Advisor reports the investor about the money he or she could lose if his or her assets would be not diverse enough. In this example, this portfolio has an 8.21% VaR 1 year. If this portfolio would not be diversified, he risk would increase till 12.07%. This investor could have 4 points more risk of losing money.

Portolio risk analysis in T-Advisor

This figure has to be linked with other T-Advisor tools and data. For instance, the picture before reports about the volatility and the effect of a diversified portfolio with that volatility.

Diversification suggestions in T-Advisor

 

In this case, T-Advisor has a follow up analytics. This chart has a report about diversification. In this example, the tool says that the diversification is low. With this low diversification, VaR is high (8.21%), but it would be worse with any diversification. The difference between diversified and undiversified VaR would be surely higher, if this portfolio had more different assets.

There are mantras amongst experts and advisors, such as “you have to diversify your portfolio”, but nobody measures with figures this advantage. T-Advisor does it and reports its users about it. Data and figures about our portfolio like this mean less chances of losing money.

Portfolio score : your investing mark

Portfolio score by T-Advisor

When we were students, we received marks from the teachers in the exams. Sometimes it went fine, others not so good. In any case, the mark was an easy reference to know if we had passed or not. Why not using it in personal finances? That is the portfolio score in T-Advisor.

T-Advisor, as software mainly thought to control and organize individuals’ investments, was designed to be easy to understand for everyone, either the person had deep financial knowledge or not. We conceive the portfolio score as a personal reference that reports about the quality of our investments related to some measures. The marks are between 0 (the worst) and 10 (the best).

Portfolio score improvement suggestions in T-Advisor

How do you receive your mark? T-Advisor accounts:

  • Diversification: the more diversified portfolio with more positions, the better, as you reduced your risks.
  • Trend: a good score has a bullish trend, against a sideways or, even worst, a bearish.
  • Risk: T-Advisor compares your risk profile against the general portfolio risk. The system defines a risk range for every profile. Think about you are conservative and your portfolio risk is high: something goes wrong and you receive a low score.
  • Performance: as before in risks, T-Advisor establishes a range for the investment profile expected return. If the portfolio return is in it, it marks. If the return is nearest to the highest point in the range, your mark will be also higher.

T-Advisor suggests the investor possible improvements in every measure. For instance, as we see in the picture above, it recommends a review of the bearish positions. How can the T-Advisor user find new investment ideas? Searching in our “Market opportunities” tool or looking at in every position report (our T-Report) some alternatives that the own system suggests.

Create your own portfolio and discover these tool functions!