Portfolio Risk Analytics: Volatility, Sharpe and Drawdown

Risk Management with NeuralEdge

NeuralEdge's Portfolio Management module goes beyond simple performance tracking. It calculates institutional-grade risk metrics that normally require expensive software such as Bloomberg Terminal or FactSet.

The Key Metrics

Annualized Return

The annualized return is calculated as the geometric mean of daily returns, projected on an annual basis (252 trading days). This method is more accurate than a simple arithmetic average because it accounts for compounding.

Annualized Volatility

Volatility is the standard deviation of daily returns, annualized using the sqrt(252) factor. NeuralEdge calculates both realized (historical) volatility and rolling volatility over 30, 60 and 90 days.

Sharpe Ratio

The Sharpe Ratio measures excess return per unit of risk: (R_portfolio - R_risk_free) / Sigma_portfolio. As the risk-free rate, we use the yield on the 3-month German Bund for EUR portfolios.

Maximum Drawdown

Maximum drawdown measures the largest peak-to-trough loss over a given period. It is a crucial metric because it indicates the worst historical scenario for the investor.

Why EUR-Hedged ETFs

An important architectural choice at NeuralEdge is the use of currency-hedged ETFs in EUR for all analyses. There are three reasons:

1. Eliminating currency risk: a globally diversified portfolio can have 60-70% of its exposure in USD. EUR/USD fluctuations can dominate performance, hiding the true alpha of security selection.

2. Comparability: by using EUR-hedged ETFs, all metrics are comparable on a consistent basis. There is no need to adjust for the currency carry.

3. Replicability: the ETFs used (iShares, Vanguard, Amundi) are all listed on Borsa Italiana and can be purchased through any European broker.

Correlation Matrix

The module includes a rolling correlation matrix that shows how correlations between assets change over time. This is essential for diversification: two assets may appear uncorrelated on an annual basis but become strongly correlated during market crises (correlation breakdown).

Conclusion

NeuralEdge's Portfolio Risk Analytics provides the tools to manage risk like an institutional professional, without the complexity and cost of enterprise platforms.