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RISK MEASURES GUIDE Risk Measures Guide v15.0 Risk Measures Guide As of Version 15 of Albridge Wealth Reporting (AWR) contains the integration of risk measures and new reports designed to deliver risk analysis on your client’s portfolios. Two types of risk measures are incorporated into AWR: ROR risk measures are rates of return that appear in risk reports. They are one singe rate of return over the whole reporting period. Sampling Based risk measures rely on a sampling of many sub-period rates of return during the reporting period. ROR “Risk” Measures Risk-Free Rate -The theoretical rate of return of an investment with zero risk. The riskfree rate represents the return an investor would expect from a risk-free investment over a specified period of time. Like any ROR it will be annualized if over 365 days. Available Risk - Free Rates include the Consumer Price Index, Citigroup 3-month CD, Citigroup Investment-Grade Bond 1-month CD, Citigroup Broad Investment-Grade Bond 3-month T-Bill, Lehman Brothers U.S. TIPS, and the Merrill Lynch 90-day Treasury Bill. Excess Return - Rate of returns in excess of the risk-free rate or in excess of a market measure, such as an index fund. In other words, when you have excess returns you are making more money than if you put your money into an index fund like the S&P 500 Index Fund. Benchmark Return -The Benchmark Return is the ROR on the benchmark over the period. If the time period is longer than 365 days the ROR’s will be annualized. Benchmark Excess Return -The Benchmark Excess Return is the Benchmark Return over the time period minus the Risk-Free Rate over the same time period. If the time period is longer than 365 days both return numbers will be annualized before the subtraction is performed. ROR Over Benchmark -The ROR Over Benchmark is defined as the ROR of the entity being analyzed (i.e. the portfolio, account, manager, or asset) over the time period minus the ROR of the benchmark over the same period. If the time period is longer than 365 days both ROR’s will be annualized and then the subtraction performed. Sampling Based Risk Measures Alpha/Jensen’s Alpha - Used to determine the excess return of a security or portfolio of securities over the security's theoretical expected return as determined by the CAPM (Capital Asset Pricing Model). Beta - This is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. A beta of 1 indicates that the security's price will move with the market. A beta of less than 1 means that the security will be less volatile than the market. A beta of greater than 1 indicates that the security's price will be more volatile than the market. For example, if a stock's beta is 1.2, it's theoretically 20% more volatile than the market. 1 Risk Measures Guide v15.0 Standard Deviation - A measure of the dispersion of monthly returns to measure an investment’s volatility. A low standard deviation indicates that all of the data points are very close to the same value (the mean); while high standard deviation indicates that the data is “spread out” over a large range of values (higher volatility). Mean -The simple mathematical average of the monthly returns during the period. The number is converted from a monthly return into an equivalent annual return. Sharpe Ratio - Measures risk-adjusted performance. The Sharpe Ratio is calculated by subtracting the risk-free rate – such as that of the 10-year U.S. Treasury bond – from the rate of return for a portfolio and dividing the result by the standard deviation of the portfolio returns. The Sharpe Ratio tells us whether a portfolio's returns are due to smart investment decisions or a result of excess risk. This measurement is very useful because although one portfolio or fund can reap higher returns than its peers, it is only a good investment if those higher returns do not come with too much additional risk. The greater a portfolio's Sharpe Ratio, the better its risk-adjusted performance has been. A negative Sharpe Ratio indicates that a risk-less asset would perform better than the security being analyzed. R-Squared -This measure is a statistical measure that represents the percentage of a fund or security's movements that can be explained by movements in a benchmark index. R-Squared values range from 0 to 100. An R-Squared of 100 means that all movements of a security are completely explained by movements in the index. A high RSquared (between 85 and 100) indicates the fund's performance patterns have been in line with the index. A fund with a low R-Squared (70 or less) doesn't act much like the index. Up-Market Capture Ratio - The Up-Market capture ratio is a measure of a manager's performance in up markets relative to the index during the same period. A ratio value of 115 indicates that the manager has outperformed the market index by 15% in periods when the index has risen (higher is better). Down-Market Capture Ratio -This ratio is the direct opposite of the Up-Market Capture ratio, gauging performance of the manager relative to the index in down markets. A ratio value of 80 would indicate the manager has declined only 80% as much as the declining overall market, indicating relative outperformance (lower is better). Risk-Adjusted Return - A concept that refines an investment's return by measuring how much risk is involved in producing that return, which is generally expressed as a number or rating (higher is better). Tracking Error - This is a divergence between the price behavior of a position or a portfolio and the price behavior of a benchmark. This is often in the context of a hedge or mutual fund that did not work as effectively as intended, creating an unexpected profit or loss instead. Tracking errors are reported as a "standard deviation percentage" difference. This measure reports the difference between the return you received and that of the benchmark you were trying to imitate. Value at Risk - This measure is a technique used to estimate the probability of portfolio losses based on the statistical analysis of historical price trends and volatilities. Sortino Ratio - A ratio developed to differentiate between good and bad volatility in the Sharpe Ratio. This differentiation of upwards and downwards volatility allows the calculation to provide a risk-adjusted measure of a security or fund's performance without penalizing it for upward price changes (higher is better). 2 Risk Measures Guide v15.0 Information Ratio - This measure is ratio of portfolio returns above the returns of a benchmark (usually an index) to the volatility of those returns. The Information Ratio (IR) measures a portfolio manager's ability to generate excess returns relative to a benchmark, but also attempts to identify the consistency of the investor. A high IR can be achieved by having a high return in the portfolio, a low return of the index and a low tracking error. Treynor Ratio - This measure is a risk-adjusted measure of return based on systematic risk. It is similar to the Sharpe Ratio, with the difference being that the Treynor Ratio uses beta as the measurement of volatility. Also known as the “reward-to-volatility ratio”. Regression Alpha - A measure of the “value added” that the individual making the investment decisions contributes. Regression Alpha shows the amount of return the manager adds that is not explained due to additional risk. 3 ©Copyright 2010, Albridge Solutions. All rights reserved. Albridge Solutions is an affiliate of Pershing LLC. Pershing LLC is a subsidiary of The Bank of New York Mellon Corporation. Member FINRA, NYSE, SIPC. Trademark(s) belong to their respective owners. For professional use only. Not for public distribution.