Blog Details
Risk or Returns: What Should Be the Focus While Selecting a PMS?
Tue, 5 Nov 2024
4 mins

Choosing a Portfolio Management Service (PMS) requires careful consideration of various factors, with the balance between risk and returns being of utmost importance. In this blog post, we delve into the essential aspects of evaluating PMS options, weighing the prioritization of risk and returns, and how to make informed decisions to align with your investment objectives.
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The Significance of Risk and Returns
Understanding Risk
Risk is an inherent component of any investment strategy. It encompasses the potential for loss or deviation from expected returns. Evaluating the risk profile of a PMS involves understanding the volatility, historical performance during market downturns, and the downside protection measures employed by the PMS provider. A thorough analysis of risk helps in assessing the sustainability of returns and the alignment of the PMS strategy with your risk tolerance.
Emphasizing Returns
Returns, on the other hand, reflect the financial outcomes generated by the PMS. While high returns are an enticing prospect, it's crucial to gauge the consistency of returns and the metrics used to evaluate performance. Additionally, understanding how the PMS has performed across diverse market cycles can provide insight into its resilience and the skill of the portfolio managers in delivering sustainable returns. -
Balancing Risk and Returns: Key Considerations
Quantifying Risk-Adjusted Returns
Strike a balance by focusing on risk-adjusted returns, which factor in the level of risk taken to achieve the returns. Metrics such as the Sharpe ratio and Sortino ratio can help in evaluating the efficiency of the PMS in generating returns relative to the level of risk undertaken. This approach enables a more comprehensive assessment that goes beyond raw returns, providing a clearer understanding of the risk-return trade-off.
The Sharpe ratio is a financial metric that measures how much excess return an investment generates for each unit of risk taken. Here's how to calculate the Sharpe ratio:
1. Subtract the risk-free return from the portfolio return to get the excess return
2. Divide the excess return by the standard deviation of the portfolio returns
Here's an example of how the Sharpe ratio can be used to compare two mutual funds:- Fund A: Has a 10% return and a standard deviation of 10%
- Fund B: Has a 10% return and a standard deviation of 14%
A Sharpe ratio of less than 1 is considered poor, while a ratio of 3 or higher is considered excellent. However, the Sharpe ratio only considers price-based risk, so it's not appropriate for debt funds.
Sortino Ratio: The Sortino ratio is a metric that measures a portfolio's risk-adjusted return. It's calculated by dividing the downside risk-adjusted return by the downside deviation.Here are some examples of Sortino ratios:
Portfolio A: 1.6 / 5% = 0.32
Portfolio B: 0.857 / 7% = 0.12
A higher Sortino ratio indicates better risk-adjusted performance. A ratio between 1 and 2 is generally considered good, while above 2 is considered very good, and above 3 is considered excellent.
Aligning with Investment Goals
When selecting a PMS, aligning the risk-return profile with your investment goals is essential. Conservative investors may prioritize capital preservation and downside protection, making a lower-risk PMS more suitable, even if it entails potentially lower returns. Conversely, growth-oriented investors may be more inclined to accept higher risk in pursuit of potentially higher returns.
Evaluating Risk Management Practices
Assess the risk management framework employed by the PMS provider. Look for transparency regarding how risks are identified, monitored, and mitigated within the portfolio. Furthermore, understanding the diversification, hedging strategies, and stress-testing procedures can offer insight into the PMS provider's approach to managing risk and protecting the portfolio from adverse market conditions.
Long-Term Sustainability
While short-term returns can be appealing, emphasize the long-term sustainability of returns and risk management practices. A PMS that seeks to deliver consistent, risk-adjusted returns over extended periods demonstrates a focus on overall portfolio performance, irrespective of short-term market fluctuations. -
How to select a PMS?
Due Diligence and Professional Advice
Conduct thorough due diligence when assessing PMS options. Review the PMS provider's track record, regulatory compliance, and client servicing standards. Seek professional advice from financial advisors or wealth managers to gain additional perspectives and insights into selecting a PMS that aligns with your risk-return preferences.
Customization and Flexibility
Look for PMS providers that offer customizable solutions tailored to your risk profile and investment aspirations. The ability to adjust the risk-return parameters in line with your evolving financial goals can enhance the suitability and efficacy of the PMS in meeting your long-term investment objectives.
Realistic Expectations
Lastly, set realistic expectations when evaluating PMS options. Understand that an optimal balance between risk and returns may not always entail the highest returns or the lowest risk. Instead, prioritize consistency, alignment with your investment philosophy, and the potential to meet your financial objectives within a prudent risk framework.
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To bring it to a close
In the realm of selecting a Portfolio Management Service, the focus should not solely rest on returns or risk in isolation. Rather, achieving a well-balanced risk-return profile that aligns with your investment goals, risk capacity, and long-term sustainability is the key.
Embrace a comprehensive assessment approach, leverage risk-adjusted return metrics, and seek customized solutions that offer an optimal equilibrium between risk and returns, creating a foundation for a successful and resilient investment journey.
If you need any further assistance you may reach out to us at 806-226-1663 or open your account, and we can help you start your investment journey.
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