- HOW DO YOU CALCULATE WEIGHTED STANDARD DEVIATION HOW TO
- HOW DO YOU CALCULATE WEIGHTED STANDARD DEVIATION FULL
This is neither intuitive nor meaningful given that a prospect would need to know the composition of the underlying portfolios to really have an idea on how to apply this information. This is because the whole calculation revolves around asset size and Portfolio 2 comprises the majority of the assets. All but Portfolio 2 fall right around two standard deviation points away. In light of the reporting requirements found within a GIPS-compliant presentation (which include annual composite returns and a measure of internal dispersion), it is reasonable to assume that a prospective client would expect the majority of portfolio returns to fall within 1.94% of the asset-weighted return, but this isn’t the case.
HOW DO YOU CALCULATE WEIGHTED STANDARD DEVIATION FULL
Portfolio Annual Return Beginning Market Valueįor illustrative purposes, assume that the six portfolios above were the only portfolios in the composite and were included for the full year. To interpret what this means when compared to a composite return, please see the following example: This all makes great in theory, but tends to be very difficult to understand and interpret. In summary, the asset-weighted standard deviation reflects the dispersion of portfolio returns around the asset-weighted average of the returns for portfolios that have been in the composite for the full year.
By using the asset-weighted average returns, the calculation is indicating that larger portfolios are more reflective of the intended strategy and as a result, the calculated mean should be weighted more heavily towards those portfolios returns. This mean return can be quite different from the composite’s asset-weighted return.Īnother misconception is that the standard deviation is based simply on the mean return when in fact it is determining what the asset-weighted average return is. The standard deviation is, however, factoring the asset-weighted mean return for only those portfolios that have been in the composite for the full year. In fact though, the reported composite return does not factor into the formula and is unrelated to the asset-weighted standard deviation of portfolio returns within the composite. It is, however, difficult to explain and sometimes even to interpret when presented alongside annual composite performance.Ī common misconception is that the composite’s internal dispersion is intended to measure the standard deviation of the underlying accounts’ returns around the composite return. The asset-weighted standard deviation of portfolio returns is a popular selection among investment managers for representing internal dispersion. The following is a best effort attempt at explaining one option: asset-weighted standard deviation. The GIPS standards do not prescribe a specific methodology (as long as the measure that is selected is applied consistently) and thus many firms struggle with this calculation. One such metric is the internal dispersion of individual portfolios within a composite. A GIPS ®-compliant presentation contains a number of required statistics.