Applied Equity Analysis and Portfolio Management + Online Video Course: Tools to Analyze and Manage Your Stock Portfolio

CHAPTER 7

Portfolio Risk and Performance Attribution

This chapter covers the calculation and interpretation of a variety of metrics for analyzing the risk of a stock portfolio and “performance attribution”—how to report returns and risk to illustrate how a portfolio's performance was achieved. We're going to take a pared-down, “what you need to know about risk” approach in this chapter. There are many outstanding sources that contain more comprehensive treatments of risk, ranging from entire books to textbooks that devote three to five chapters devoted to the topic. In an attempt to add some unique value, I am going to present more of a narrative-driven approach to the topic, starting from “square one” and building what I hope will be an easy-to-understand foundation for your deeper explorations of this topic as your careers progress.

The learning objectives for this chapter are:

1. Explain, interpret, and calculate basic statistics such as expected value, variance, standard deviation, covariance, and correlation.

2. Calculate and interpret the expected return and standard deviation of a stock portfolio and compare investment portfolios based on mean/variance efficiency.

3. Identify the subcomponents of portfolio volatility, interpret the type of risk each subcomponent represents, and explain why only one of the subcomponents is affected by diversification.

4. Identify and explain the two key drivers of beta.

5. Interpret the concept of beta in a linear regression context.