Portfolio performance evaluation is a crucial aspect of investing, and it helps investors determine how well their investments have performed over a particular period. Evaluating portfolio performance can be done using various metrics and methods, and in this article, we will explore some of these methods, their pros and cons, and provide examples related to Indian markets and funds.
- Absolute Return
The absolute return is the most straightforward method of evaluating portfolio performance, and it measures the actual returns of the portfolio over a given period, regardless of any benchmark. For example, if an investor had invested Rs. 100 in a mutual fund and the value of the investment increased to Rs. 120, the absolute return would be 20%.
One of the drawbacks of this method is that it does not take into account the risk taken to achieve the returns. Moreover, it does not provide a benchmark against which investors can compare their returns.
- Relative Return
Relative return is a method that compares the returns of a portfolio to a benchmark index over a given period. For example, if an investor’s portfolio returned 15%, and the benchmark index returned 12%, the relative return would be 3%.
Relative return provides a benchmark against which investors can compare their portfolio performance, but it does not consider the risk taken by the investor. Moreover, the benchmark index may not be a suitable comparison if the portfolio’s investment strategy differs from the index.
- Risk-Adjusted Return
Risk-adjusted return is a method that takes into account the level of risk taken to achieve the returns. One of the most common methods of risk-adjusted return is the Sharpe Ratio, which measures the excess returns earned over the risk-free rate per unit of volatility. For example, if an investor’s portfolio had a Sharpe Ratio of 1.5, it means that the portfolio generated 1.5% of excess return for every unit of risk.
Risk-adjusted return provides a better measure of portfolio performance as it considers the risk taken by the investor. However, it may not be suitable for all types of investments, and it may not provide a benchmark against which investors can compare their returns.
Examples related to Indian markets and funds:
Let us consider the following examples related to Indian markets and funds to illustrate the methods of evaluating portfolio performance:
- Absolute Return: If an investor had invested Rs. 100 in HDFC Equity Fund five years ago and the value of the investment increased to Rs. 200, the absolute return would be 100%.
- Relative Return: If an investor’s portfolio returned 12% over a year, and the benchmark index returned 10%, the relative return would be 2%.
- Risk-Adjusted Return: If an investor’s portfolio had a Sharpe Ratio of 0.5, it means that the portfolio generated 0.5% of excess return for every unit of risk.
Conclusion:
Evaluating portfolio performance is essential for investors to determine how well their investments have performed over a particular period. The methods of evaluating portfolio performance have their pros and cons, and investors should choose the most suitable method based on their investment needs and preferences. In India, various portfolio management tools and software, such as Moneycontrol Portfolio Manager, MProfit, Groww, and Zerodha Coin, offer these methods to evaluate portfolio performance. It is recommended that investors evaluate their portfolio performance regularly to make informed investment decisions.
