What is Portfolio Analysis?
Portfolio analysis is a quantitative technique that is used to determine the specific characteristics of an investment portfolio. The process of analyzing a portfolio involves several stages, including a statistical performance review, risk and risk-adjusted metrics, attribution, and positioning. The goal of analyzing an investment portfolio is to help investors decide whether it has achieved its objectives and identify areas that can be optimized. In this blog, we explore all these aspects along with additional links to other resources.
Key Learning Points
- Portfolio analysis is at the core of the decision-making process in investment management and a solid understanding of the market and asset class fundamentals.
- The key aim of analyzing a portfolio is to establish whether it has performed in line with expectations over a specified period, the level of risk assumed, and the attribution of returns.
- It is important to note that portfolios vary widely – investors should carefully consider factors such as the investment style and objectives, risk budget and portfolio composition.
- Although the basic concepts of portfolio analysis are well-established, methods are constantly evolving and now analysts must consider integrating ESG factors into the analysis.
Steps in Portfolio Analysis
The analysis process can differ depending on investment philosophy, composition, and objectives, but generally involves multiple layers of quantitative analysis. Below are some of the key steps.
Performance analysis assesses how well a portfolio has performed over a specific period, helping investors evaluate the success of their investments. This is done both on absolute and relative basis. Below is an example of a growth-oriented portfolio, the T. Rowe Price Global Growth Equity Fund, and its performance against the broader market (the MSCI World Index) and its target benchmark (the MSCI World Growth Index).
The most common measure of relative performance for benchmarked strategies (i.e., those seeking to outperform a specific index) is alpha. This performance measure represents the excess return generated over a benchmark’s performance.
To successfully analyze performance, investors should pay attention to the following key rules:
- Benchmarks are relevant to the portfolio.
- The benchmarks must be measurable.
- The performance periods examined should be consistent with the portfolio’s time horizon unless the deviation is for a specified reason (for example, to understand how a portfolio performed during a particular market event)
By analyzing the risk in their portfolio, investors can gauge the likelihood of future fluctuations or financial losses. Like performance, risk must be considered relative to factors that are relevant to the portfolio such as specific indices, peer groups, or custom benchmarks.
The most popular risk measure is standard deviation, which illustrates a portfolio’s volatility over a certain period.
There are some cases in which higher volatility is desired to potentially achieve higher returns. In such scenarios, risk can be considered from other perspectives, including:
- Debt levels of underlying holdings and/or their
- Portfolio drawdowns over multiple periods (drawdowns are explained in our blog on Portfolio Risk Management).
- Upside capture ratio – this is a measure of the portfolio’s performance in rising markets relative to a benchmark index. A value above 100 indicates that the portfolio has outperformed the benchmark during periods of positive benchmark returns. For instance, an upside capture ratio of 110 indicates that the portfolio outperformed the benchmark by 10% during the period in question.
- Portfolio’s This indicates the relationship between portfolio performance and broader market performance.
Risk-adjusted returns relate portfolio performance to the level of risk taken. This provides a measure of how well returns compare to the inherent investment risk. Some of the most common risk-adjusted performance ratios include the Sharpe and Sortino ratios – we have explored them in this blog on Risk Based Performance Measures.
Other Important Considerations
In addition to the ratios mentioned above, investors typically examine their portfolios from additional angles. For example, the dividend yield of an income-focused portfolio is typically reviewed against the yield offered by an index constructed of dividend-paying companies. Another example can be a value-oriented portfolio, which is reviewed against its benchmark in terms of valuations – be it from a P/E , P/B, or other ratio perspective.
Tools Used in Portfolio Analysis
Portfolio positioning describes how are the portfolio’s assets are spread across various asset classes, investment styles, company sizes (for equities), durations (i.e. the sensitivity to changes in interest rates) and credit quality (for fixed income), geographies and factors.
Below is an example of the portfolio positioning for the Fidelity Multi Asset Income Fund. In terms of asset allocation, most funds are invested in bonds (which pay regular coupons in line with the strategy’s income objective) with the remainder spread across equities, cash, and other assets (which may include more niche market segments such as illiquid investments).
Morningstar’s Stock Style Box is a good tool to compare strategies and portfolios against a benchmark and peer group. Below is an example of how the JP Morgan Emerging Markets Fund is positioned against the MCSI Emerging Markets Index and the Global EM Category (a group of peers invested in emerging markets). The fund is growthier than both comparators (i.e., has more exposure to growth companies) and has a slight bias towards larger companies compared to the index and the category average (meaning that the average size of a company in the portfolio is larger).
Whether analyzing a style-biased or agnostic portfolio, it is crucial for investors to make relevant comparisons both against an appropriate benchmark and a peer group of similarly positioned strategies. Portfolio characteristics are part of a broad group of statistical and valuation measures that help investors assess more closely how aligned the portfolio is with their philosophy. For example, below you can see the portfolio characteristics of the Jupiter Global Value Equity Fund. As we would expect for a value-oriented strategy, its valuation multiples in terms of P/E, P/B and P/S are lower against both the benchmark index and the peer group category average. Lower P/E ratios in a portfolio setting typically mean that it is predominantly composed of securities that are trading at lower valuations relative to their benchmark peers. Although the fund does not have an explicit income mandate, it also shows higher dividend yield as most of the companies in this universe pay higher dividends to compensate investors for the lower capital growth they deliver.
Portfolio attribution is a quantitative analysis used to assess the sources of portfolio returns. It examines the impact of factors like asset allocation, security selection, and market movements, helping investors understand the main performance drivers and detractors.
The chart below shows some attribution details for the T. Rowe Price Global Growth Equity Fund. It looks at which sectors have added and detracted the most to its performance. The lead contributors have been holdings in the Utilities sector by adding 0.19% to performance, 0.11% of which came from sector allocation (the manager being positioned in this market segment) and 0.08% from stock selection (active stock picking in the sector). On the other hand, Financials detracted from returns by 0.33%, 0.06% of which came from sector allocation and 0.39% from stock selection.
Below is an attribution analysis for the BlackRock Total Return Fund, which has a diversified core bond portfolio and seeks to deliver consistent performance through market cycles. The attribution of each type of fixed income security is shown over multiple periods (in this example each quarter).
Portfolio analysis offers numerous advantages, including solid quantitative insights into asset performance and risk metrics, and helps examine overall adherence to portfolio objectives. Regular portfolio reviews can improve the efficiency of asset allocation, provide a detailed view of stock selection results, and reveal the lead contributors and detractors for a portfolio’s performance. Overall, this analysis supports the investment decision-making process. In addition, portfolio analysis can also improve cost efficiency should transaction and ongoing management charges be considered as part of that exercise.
Below is the Morningstar Style Map and Portfolio Statistics for the Baillie Gifford Global Discovery Fund. Analyze the information provided and make assumptions for the fund’s portfolio.
Access the portfolio analysis workout to see how we would make assumptions for the fund’s portfolio.
Examples of How to Write a Portfolio Analysis Report
Writing a portfolio analysis report uses the concepts in this blog incorporated into a more formal structure. Although requirements could vary depending on the organization and client demands, below is a rough guide to creating such a report.
- Executive Summary – This is an overview of the report’s key findings and recommended actions.
- Brief introduction of the purpose of the report and the portfolio’s objectives.
- Overview of the portfolio, including its size, composition, and any specific constraints or benchmarks.
- Evaluation of the portfolio’s performance against its benchmark and peer group.
- Risk assessment including measures of volatility and/or other specific factors.
- Attribution Analysis
- Portfolio Positioning
- Asset Allocation
- Style / Market Cap / Duration / Quality Exposure
- Sector Exposure
- Regional Exposure
- Currency Exposure
- Factor Exposure. Factor investing involves selecting securities based on specific characteristics that are believed to drive asset returns. The most popular factors include style, yield, momentum, quality, volatility, liquidity, and size).
- Recommendations and conclusion
Portfolio analysis is a key part of the investment management, investment research, and risk management processes. Although it can be quite time-consuming, it allows investors to fairly assess the performance, risk, and positioning of their portfolio, and adjust where necessary. Depending on the size of the firm and the complexity of the strategy, larger asset managers typically have dedicated roles that are exclusively focused on portfolio analysis. Other types of roles that require portfolio analysis skills include portfolio manager, risk manager, investment adviser, consultant, and analyst.