Definitions of Risk and Return Measures

Portfolio Return

Portfolio return is the percentage by which the value of a portfolio has grown for a particular period. The return calculation adopted is Holding period return (HPR). For a particular day, it is calculated as the market value at the end of the day, (MVend), divided by the market value at the beginning of the day, (MVbeg), plus any in or outflows and other flows (e.g. fees charged or income earned), minus 1:

equation

This return is calculated daily. To calculate a month's holding period return (for a month with 30 days), the daily holding period returns are geometrically linked as follows:

equation

Sharpe ratio

The Sharpe ratio measures the excess return per unit of risk. The higher the ratio, the better the portfolio is performing. It is also known as the Reward-to-Variability Ratio.

equation

Where is the return of the portfolio, and is the risk free rate (e.g. Short Term Fixed Income rate), is the annualized standard deviation of the portfolio returns.

Sortino ratio

The Sortino Ratio is a modification of the Sharpe ratio but penalizes only those returns falling below a specified minimum acceptable return, while the Sharpe ratio penalizes both upside and downside volatility equally. It is thus a measure of risk-adjusted returns that treats risk more realistically than the Sharpe ratio.

equation

Where is the return of the portfolio, and is the return of the Consumer Price Index (CPI). is the annualized standard deviation of the excess returns above CPI in those months when the excess return was negative.

Maximum Drawdown

This is the maximum loss (compounded, not annualized) that the portfolio has ever incurred during any sub-period of the entire duration of the fund since inception. Conceptually, the calculation looks at all sub-periods of the time period in question and calculates the compound return of the manager over that period. The maximum drawdown is the minimum of zero and all these compound returns. The figure below shows an example of the maximum drawdown (MDD) over a period T, highlighted in red:

equation

Information Ratio

The Information ratio is a measure of the risk-adjusted return of a portfolio and is often used to gauge the skill of managers. It measures the expected active return of the portfolio divided by the amount of risk taken relative to the benchmark. The higher the information ratio, the higher the active return of the portfolio, given the amount of risk taken.

It is defined as active return divided by tracking error, where active return is the difference between the return of the portfolio ( ) and the return of the benchmark ( ), and tracking error is the annualised standard deviation of the active return ( ).

equation
 
 

WE WERE THE FIRST SOUTH AFRICAN INVESTMENT MANAGER TO SIGN THE UNITED NATIONS PRINCIPLES FOR RESPONSIBLE INVESTMENT

WE ARE COMMITTED TO THE CODE FOR RESPONSIBLE INVESTING IN SOUTH AFRICA