An Optimal Portfolio

Risk-Adjusted Return

WHAT IS RISK-ADJUSTED RETURN?

Understanding the relationship between risk and return is essential for achieving consistently superior investment performance. At the same time, emotional needs and personal preferences like risk appetite, which is the level of risk an investor is comfortable exposing their portfolio to are important to the success of a financial plan. You might expect a 0% yield (i.e., return) for a risk of zero. The high risk of a certain investment may be worth its high potential yield for some investors, while other investors would rather be more certain of lower yields in exchange for less comparative risk.

Risk adjusted return factors in both risk and yield into the assessment of a portfolio, investment or asset class. Essentially, by taking a look at risk-adjusted returns, investors are able to compare the performances of an investment or investment portfolio relative to its risk. In this way, investors are better able to understand just how much risk they’re exposing themselves to, and how great their potential reward may be for doing so.

IS IT POSSIBLE TO REDUCE RISK AND INCREASE RETURN AT THE SAME TIME?

Yes. This is what risk-adjusted return is all about. By incorporating investments with higher risk-adjusted returns, investors don’t necessarily have to jeopardize their level of risk exposure to get closer to achieving the investment results they want. In fact, because they tend to be loosely correlated or uncorrelated with the performance of other asset classes even during periods of poor or volatile broader market performance, alternative investments have historically secured for investors a means through which to moderate their risk-return profile.

For this reason, depending on the composition of an investor's larger portfolio, introducing or increasing allocation to alternative investments is a potential way to improve a portfolio's cash flow, capital protection and capital appreciation performance characteristics - reducing average risk and providing for increased return at the same time.


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