Rating Portfolios and Funds

High portfolio complexity may influence negatively mid and long-term expected returns.  This is because highly complex portfolios are generally more volatile hence more fragile. Complexity is, in fact, a new and modern measure of volatility, which takes into account the intricacy of the dynamics of portfolio components and of the changing structure of their interactions.

Universal Ratings provides the capability of quantifying the complexity and obtain measures of vulnerability of portfolios or funds, providing a breakdown of portfolio fragility into components.

Portfolios have rapidly changing structure. In order to understand better the functioning and dynamics of a portfolio it is necessary to understand the structure of the interation of its components. An interactive example of the so called Complexity Map of a portfolio based on Dow Jones stocks is shown here.

Two simple examples are illustrated below. Portfolios are constructed based on securities illustrated here.

Example 1

A simple portfolio consisting of six low-complexity securities has the following characteristics (April, 2016):

Complexity: 7.42

Resistance to Shocks : 94%

The ranking of the various securities in terms of their impact on portfolio resilience is illustrated below. Values are in percent. The chart is not updated.

Ranking of securities in terms of impact on portfolio resistance to shocks(%)

Low-complexity portfolio. The securities that drive the resistance to shocks and complexity of the portfolio are: BUNL, XVZ and JPM. Information in this chart is not updated.

 

Example 2

A simple portfolio consisting of six high-complexity securities has the following characteristics:

Complexity: 8.9

Resistance to Shocks: 71%

The ranking of the various securities in terms of their impact on portfolio resilience is illustrated below. Values are in percent. The chart is not updated.

Ranking of securities in terms of impact on portfolio resistance to shocks (%)

High-complexity portfolio. The securities that drive the complexity and resistance to shocks of the portfolio are: KLEM, XTN and GE. Information in this chart is not updated.

It is interesting to confront our rating of portfolios or funds with their conventional ratings. Like in the case of listed companies, this provides a new dimension and new insights into the structure and sustainability of investments. The analysis is particularly interesting to Asset Management companies which manage systems of hundreds or thousands of funds and portfolios. The map below illustrates the structure of a system of funds.

Complexity map of a system of 39 funds

Complexity map of a system of 39 funds

The size of each node in the above map is proportional to the impact of each fund to the overall Resistance to Shocks of the system. In other words, funds 3, 4, 17, 22, are those that influence the overall exposure of the AM company managing the system of funds and this is where risk management should direct more attention.