Stock and Bond Market Risk Measures: A Review of Common Risk Statistics


There are many ways to measure risk in a stock or bond portfolio. Investors might look at price volatility, return fluctuation in relation to a benchmark, how a portfolio responds in a down or up market, and more. The following are common statistics investors use to help align their portfolios with their individual risk tolerance and set them up for optimal risk-adjusted returns.

Beta

Beta is a measurement of a portfolio’s performance relative to its benchmark. For instance, a beta of 1.5 reflects a portfolio which has historically moved 1.5% when its benchmark moves 1%. The limitations are built into this definition. A portfolio’s beta increases even when it exceeds its benchmark to the upside, a result that does not typically concern investors. It also tells you nothing about the risk parameters of the underlying benchmark: a low beta backed by a widely fluctuating benchmark may still be a ride wilder than most investors would like.

Sortino Ratio

The Sortino Ratio seeks to improve other risk measurements by focusing on losses, the volatility most investors are concerned about. In general, the higher the Sortino Ratio, the better. A small sample of downside events can compromise the usefulness of this measure. Another liability is that it can fail to capture the frequency of losses: a portfolio with one downside event of -10% over a period may have the same Sortino Ratio of a portfolio which has four -10% events in the same period, a difference of no small interest to real-world investors.

R-squared is another benchmark-related measure. It describes the percentage of a portfolio’s movements that can be explained by the ups and downs of a benchmark. Its value is measured in percentage terms from 0% to 100%. The higher the percent, the closer the portfolio marches in time with its benchmark. But once again, this does little to express the potential for loss inherent in either the portfolio or its benchmark.

Tracking Error

Some managed investment products are designed to mirror the performance of a specific, unmanaged index. The degree to which the managed product underperforms or outperforms its index is designated tracking error and is typically measured in percentage terms over standardized periods.

Sharpe Ratio

The Sharpe Ratio looks at a portfolio return through the lens of a risk-free alternative, such as the purchase of U.S. Treasury bills (which hold a Sharpe Ratio of 0). In general, the higher the Sharpe Ratio, the more attractive is the risk-adjusted return. A portfolio that has achieved higher returns with less volatility will have a higher Sharpe Ratio and typically sport a Sharpe Ratio of 1 or higher. But this number, like Beta, punishes for upside volatility and doesn’t quantify potential downside, particularly when the portfolio contains options or other leveraged investments.

Upside & Downside Capture Ratio

Capture ratios are a useful way to look at historical patterns of a particular manager or management style. It is a percentage measure of how much a portfolio matches an index’s up and down movements. For risk-averse investors, a low downside capture ratio may be particularly attractive. However, this measurement is subject to definitional parameters (do you measure daily, monthly or quarterly periods?) and does nothing to express the volatility of the underlying benchmark. Over a particular period, risk can be masked by prevailing market trends. For instance, in a nine-year bull market, the five- and even ten-year downside capture ratios may not reflect the deep bear market performance.

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Any performance data shown represents past performance. Past performance is no guarantee of future results.

Non-deposit investment products are not federally insured, involve investment risk, may lose value and are not obligations of, or guaranteed by, any financial institution. Investment returns and principal value will fluctuate.

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