Build your own benchmark

Standard benchmarks such as the S&P500 and Russell indexes are commonly used for performance analysis because of their ubiquity. However, they represent specific asset classes so they are not appropriate as a benchmark for a diversified portfolio that covers multiple asset classes.

With Portfolio Lab, you can build a model portfolio made of indexes, and use this model portfolio as a benchmark. To create your benchmark:

  1. Use ‘Edit->New’ to create a new model portfolio. Enter the benchmark name as the portfolio name.
  2. Enter the index constituents of the benchmark with their weights. In Portfolio Lab, the index tickers start with ‘$’.
  3. Select rebalancing: monthly

Your newly created portfolio can now be used as a benchmark. Whenever you need this benchmark, click Compare option in backtest, then A portfolio, then select your benchmark. You may also use this as a benchmark in the PDF report.

If a particular index is not available, you may also use ETFs as proxies for benchmarks.

Visualizing the maximum drawdown

Portfolio Lab reports the maximum drawdown in the backtest module. We added a visualization of the drawdown on the return chart, along with the drawdown peak, trough and duration, as shown below:

Maximum drawdown

The maximum drawdown of a portfolio for a given period, is the biggest decline in value from peak to trough. Drawdown is one of many metrics for risk. Its advantage is to be fairly intuitive and understood by most investors.

Efficient portfolios

Enhanced interface for portfolio optimization: use the slider to glide along the efficient frontier.

Assign the weights of the efficient portfolio to the current portfolio, or to a new portfolio.

ETF flows as a contrary indicator

Equity prices tend to fall after ETFs rake in large sums of money. A study by TrimTabs Investment Research finds that monthly equity ETF flows and returns of the S&P500 one month later are negatively correlated to the tune of 21.4%.

The study concludes: “We have two explanations for the strongly negative correlation between equity ETF flows and future market returns. First, ETFs are traded mostly by retail investors and day traders.  These are the least informed and most emotional market participants—the ones most likely to lose money over time.  Second, we suspect hedge funds use ETFs when liquidity dries up.  Hedge funds were forced to close individual stock positions during the credit crisis, so they bought equity ETFs instead. Equity ETFs posted large outflows in 2009, when liquidity improved”.

Daily returns correlation

Portfolio Lab calculates the correlations of either monthly or daily returns:

  • Monthly returns correlation is preferred in the context of strategic investment decisions
  • Daily returns correlation may be useful for short term trading and tactical moves.

Note that Portfolio Lab correlations are exponentially weighted, i.e. the most recent data points are given more weight in the computation, which has advantages over the more common equal weights computation.