Risk and Return Measurement: A Comparative Analysis of ETFs (Finance)

This report investigates the appropriate methods for measuring risk and return in financial investments, focusing on the analysis of two ETF securities, STW and SLF. The study utilizes standard deviation and beta as key metrics to assess the risk-return trade-off, comparing the performance of both ETFs over a five-year period. The research aims to identify the most effective approach for portfolio managers to evaluate investment opportunities, concluding that both standard deviation and beta are valuable, though beta offers a more comprehensive risk assessment. The findings indicate that STW presents a more favorable risk-return profile compared to SLF. The report includes a detailed comparison of the returns and risks associated with each ETF through charts and statistical analysis, providing insights into the volatility and potential returns of each security. It emphasizes the importance of considering both risk and return when making investment decisions, especially when choosing between high-volatility and low-volatility options, offering a nuanced perspective for investors with varying risk tolerances. The report concludes by highlighting the significance of using both beta and standard deviation in measuring risk and return for effective portfolio management.

WHAT IS THE APPROPRIATE WAY TO
MEASURE RISK AND RETURN

ABSTRACT
Portfolio managers usually use standard deviation and beta to make investment decisions. Main
intention behind using these approaches is to identify level of risk associated with secutities that
form portfolio. Currrent, research study investigate different approach that can be used to
measure risk and return and best one among them that can be used reliably by portfolio managers
in their day to day practice. In present research study in order to support this investigation three
objectives are prepared. First objective is to identify best approach to analyze risk and return
trade off in respect to security STW which is ETF. Second objective is to analyze risk return
trade off in case of security SLF which is also ETF and third objective is to identify which of
these schemes have best risk and return trade off. Results obtained in present research study
confirm that both standard deviation and beta seems appropriate measure to meausre risk.
Standard deviation only consider single variable to measure risk whereas beta is used to compute
risk by considering multiple variables. In research it is identified that there is huge significence
of both apporaches because both measure risk in different manner. However, beta is more
efficient measurement of risk then standard deviation. Thus, in order to mesausre trade off
between risk and return beta and standard deviation both must be used and same is done in
present research study. For specific security trade off can be revealed by beta but for other one
same can be revealed by standard deviation. Hence, both are appropriate methods of identifying
trade off between risk and return. Results obtained in current research study are indicating that
STW is the best trust that have better risk and return trade off. This is proved from the beta
chart where return and risk are moving up and down at same rate. Hence, STW trust have better
risk and return trade off relative to SLF.

TABLE OF CONTENTS
ABSTRACT....................................................................................................................................3
INTRODUCTION...........................................................................................................................1
Appropriate methods to measure historical risk and return in investment.................................1
Comparison of return of both ETF for five years........................................................................2
Comparison of risk of investment for five years.........................................................................5
Best way to analyze risk and return trade off in case of SLF......................................................7
Best way to analyze risk and return trade off..............................................................................9
Summary statistics.....................................................................................................................11
CONCLUSION..............................................................................................................................13
Table 1Return and standard deviation of SLF.................................................................................7
Table 2Standard deviation and return..............................................................................................9
Table 3Summary statistics.............................................................................................................11
Figure 1SLF price chart...................................................................................................................3
Figure 2STW price chart.................................................................................................................3
Figure 3Return comparison of securities.........................................................................................4
Figure 4Standard deviation of SLF..................................................................................................5
Figure 5Standard deviation of STW................................................................................................6
Figure 6Comparison of standard deviation......................................................................................6
Figure 7Trade off chart....................................................................................................................8
Figure 8Trade off chart with beta....................................................................................................9
Figure 9Trade off chart..................................................................................................................10
Figure 10Trade off chart in case of beta........................................................................................11

INTRODUCTION
Financial management is the one of the most important approach that is used for making
varied finance related decisions. In present research study main aim is to find out appropriate
way to measure risk and return associated with security. In order to achieve three objectives are
prepared which are to identify risk and return trade off in respect to security STW and SLF and
identifying best one trust where risk and return trade off exist. Risk and return trade off basically
reflect situation where accoridng to risk return is earned by investor. Risk is the factor to which
people give much importance while making investment in any security. Risk and return are
closely associated with each other. If there is heavy risk on investment return is also high or risk
is low return is high. This reflect that both risk and return are closely associated to each other.
However, there are some securities where in case there is heavy risk good amount of return is
also earned on it. Thus, one must be very cautious while making investment related decisions. In
the current report appropriate tools to measure risk and return are identified. Apart from this,
ETF are compared for 5 year and best tool that can be used for analysis of risk and return trade
off is identified. Investment is made in securities by individuals and business firms of small and
large amount. There is common intention of people that if they are taking heavy risk on
investment then return must also be high. This is because risk is high then obviously one will
want to earn more amount so that taking a heavy amount of risk can be justified. This thinking
of investors is covered by topic of trade off between risk and return. Concept of trade off
between risk and return reflect that if risk is high then return must also be high on investment. In
the current report, approriate method of historical risk and return are described in detail. In depth
discussion is carried out on these approaches like standard deviation and beta values. In middle
part of the report best way to analyze risk and return is identified and in this regard standard
deviaton and reuturns are compared with each other and results are discussed in detail.
Appropriate methods to measure historical risk and return in investment
In order to measure historical return there are two approahces that are usually used by
researchers in their business namely beta and standard deviation. Beta is the one of the most
important tool that is used to measure risk on investment (Boyle and et.al.,, 2012). Under this
apperoach simple percentage change that happened in share price is computed and then
percentage change that happened in index is computed. By using slope function beta of two
variables is computed. Beta value may be positive or negative. In case beta value is zero it is
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assumed that there is no relationship between dependent and independent variable or there is no
relationship between return that is earned on index and stock. Means that direction in which
changes happened in stock and index are in diverisifed direction. It is the one of the best method
that is used to measure historical risk on stock. Beta value is also used to compute cost of equity
that is used to calculated weigthed average cost of capital in the business. Apart from this,
standard deviation is an another tool that is used to measure risk that is associated security.
Standar deviation reflect extent to which values of variables are scattering from their mean value.
In case value of standard deviation is high it is assumed that values of variable is moving at slow
rate. In contrast to this, if it is identified that there is heavy deviation then it is assumed that
values of variables are moving at fast rate and there is huge gap between predicted and mean
value. There is huge significence of both approaches for the portfolio managers because beta
takes in to acount percentage change in return that happened in stock and index. On other hand,
in case of standard deviation only single variable is taken in to account. There is appropriateness
of both approaches because if one want to measure volatility in stock by considering single
variable then in that case standard deviation is approproiate. Apart from this, if one want to
measure volatility of stock by consdiering multiple factors then in that case beta seems
appropriate for the business firm. It depend on an individual requirements that which of
historical risk tool it used to measure overall risk on investment.
In order to measure historical return there are number of approaches that can be used by
the analysts in the business. Computation of percentage change in closing price of security is the
one of the best approach to measure historical return on investment amount. Apart from this, in
order to meaure historical return in approriate manner Sharpe and Trenyor ratios are commonly
used by the business firms. Sharpe ratio basically reflects the return that is earned on each unit of
standard deviation after subtracting risk free rate from return that is earned on investment
amount. On other hand, Trenyor ratio is another approach that can be used to measure historical
return because in this method return that is earned on each unit of beta is measured. Like Sharpe
ratio in this method also from return that is earned on security risk free rate is subtracted and then
computed amount is divided by beta to meausre performance of specific stock. In this way,
historical return is measured.
Comparison of return of both ETF for five years
SLF
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1
5
9
13
17
21
25
29
33
37
41
45
49
53
57
61
65
69
73
77
81
85
89
11
11.5
12
12.5
13
13.5
14
Figure 1SLF price chart
In case of SLF it can be observed that return are fluctuating at fast rate as chart is clearly
indicating that up to certain limit price of ETF declined at very high rate after decline in price
from 13.5 to 11.5 boom comes in its price and value rose againbut it faield to raised up to
previous heights. This is clearly reflecting that there is pressur on the price of ETF. In 2017 again
sharp fluctuations are observed and due to this reason it is very difficult to estimate the likely
direction in which price of ETF may move. It can be said that there is huge growth potential in
ETF and if economic condition of nation get improved then in that case ETF may generate good
return for the investors.
STW
1
5
9
13
17
21
25
29
33
37
41
45
49
53
57
61
65
69
73
77
81
85
89
51.5
52
52.5
53
53.5
54
54.5
55
55.5
Figure 2STW price chart
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In case of STW it can be observared that returns are not stable at specific point as they are
fluctuatinng in specific range. As it can be observed from the above image that mostly ups and
downs in price of ETF are in range of yellow lines. 95% of observations comes within this line
which is clearly reflecting that return on consistent basis is given by ETF and after reaching
certain level below it again elevate at fast rate towards upper part. Thus, there is stability in
return that is generated by STW for investors. Share price almost remain in range of 53.5 to 54.5.
1 55 109 163 217 271 325 379 433 487 541 595 649 703 757 811 865 919 973 10271081113511891243
-0.05
-0.04
-0.03
-0.02
-0.01
0
0.01
0.02
0.03
0.04
0.05
Chart Title
SLF Closing price STW closing price
Figure 3Return comparison of securities
Chart that is given above is clearly reflecting that SLF is fluctuating at fast rate the STW.
Almost most of times higher return is generated by SLF then STW but in case of declining trend
also it is observed that at same return huge decline happened in ETF value. However, chart is
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clearly reflecting that increasing bars are much higher in chart relative to STW then in case of
declining bars. Hence, it can be said that SLF is generating better return for investors then STW.
Due to this reason it will be good for investor to make investment in SLF then STW. However,
this can not be a good choice for those investors that are risk averse in nature and does not
believe in taking very high risk in business. It can be said that those investors that believe in
taking risk must make investment in SLF and those who does not believe in taking high level of
risk must make investment in STW.
It can be said that return profile of both securities is totally different and due to this
reason cautiously investment decisions must be taken by the managers. It depends on investors
that which of options that choose from investment point of view. Highly volatile ETF can
generate better return but in case of loss then can lead to facing heavy loss on invested amount.
Hence, there are both positive and negative sides of huge price plunge behaviour of security for
investors.
Comparison of risk of investment for five years
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
0.4
0.45
0.5
0.12235037958508
9
0.18378022708315
8
0.37192215754085
1
0.31614744400233
0.23009918496299
6
0.14484049105032
6
0.14031658194739
1
0.22317701078309
2
0.41090538122934
40.38609661125207
9
0.25296354694366
6
0.25296354694366
6
0.20841512987172
3
0.04358898943540
68
0.32722054686453
1
0.47406954630300
3
0.37914635422135
5
0.22591368824292
0.28304318121326
8
0.17850175804223
3
STDEV OF SLF
Figure 4Standard deviation of SLF
It can be seen from chart given above that standard deviation is moving in head and shoulder
pattern. Every time standard deviation of SLF ETF increased but then it declined at same rate.
Again further increase is observed in value of standard deviation but then again decline comes in
standard deviation. This chart is reflecting that on each quarter trend is equal opposite in
deviation in comparison to previous trend. Hence, it can be said that risk level get changed at
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very fast rate in case of SLF and investor on basis of past trends can make estimate about likely
trend in upcoming time period. It can be said that risk is very high in case of SLF and it can not
be right choice for those who easily loose their patience while making investment in security.
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
0
0.5
1
1.5
2
2.5
0.68506843031767
6
1.36946442078856
1.6862934614405
1.45761823441635
0.96884891234224
1
1.06808000526813
0.49636035482585
2
0.89240083735993
3
1.01373470724589
2.14917435404138
1.178704371804651.17870437180465
0.80670612843275
30.66785776929098
6
1.16625939693887
0.92533132882446
7
1.32266672256633
0.81422379558153
50.66291763597611
8
0.33559571004499
STDEV OF STW
Figure 5Standard deviation of STW
STW is another ETF on which analysis is done in current report in case of STW it can be
seen that trend in past time period was consistent as it can be seen that risk level remain same
almost for first three quarters and then it get changed and remain same for again three quarters.
Almost up to 2.5 years this trend keeps on going consistently but in latter stage it can be
observed that risk level reduced in case of STW at very fast rate as compared to previous
quarters. Hence, it can be said that there is very low amount of risk that is associated with STW.
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1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
0
0.5
1
1.5
2
2.5
Chart Title
STDEV OF SLF STDEV OF STW
Figure 6Comparison of standard deviation
Chart that is given above is clearly reflecting that standard deviation of STW is very higher then
SLF. There is huge gap between standard deviation of both ETF as it can be seen that standard
deviation is above 0.5 in case of STW and in case of SLF always value is below 0.5 which
clearly reflect that huge gap exist between both ETF in terms of standard deviation. It can be said
that there is very low risk in case of STW then SLF. Apart from this, trends in SLF are more
reliable then STW and on this basis it can be said that risk is not only low in case of SLF but
there is stability in fluctuatations which ensured that in case of it is very easy to estimate risk in
case of SLF then STW. Thus, one if consider risk profile then it can make investment in SLF
because by doing so less high level of fluctuations can be observed on investment and good
return can be gained on it. Hence, by considering only risk factor SLF seems to be proper
investment option. However, if along with risk return profile will also considered then in that
case it can be said that SLF is better option because risk is low and return is high. This also
means that there is no trade off between risk and reutrn in case of these ETF. This is because
trade off comes in existence when risk is high return is also high and risk is low then return is
also low. Opposite happened in case of both ETF as if risk is low return is high and risk is high
then return is low.
Best way to analyze risk and return trade off in case of SLF
Table 1Return and standard deviation of SLF
SLF return
STDEV OF
SLF
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Q1 0.014908257 0.12235038
Q2 0.020652174 0.183780227
2012-
13 Q3 -0.002116402 0.371922158
Q4 -0.025 0.316147444
Q1 -0.011764706 0.230099185
Q2 0.009698276 0.144840491
2013-
14 Q3 0.048370137 0.140316582
Q4 0.006072874 0.223177011
Q1 0.122367101 0.410905381
Q2 0.085766423 0.386096611
2014-
15 Q3 0.09 0.252963547
Q4 0.032632194 0.252963547
Q1 0.017241379 0.20841513
Q2 0.051150895 0.043588989
2015-
16 Q3 0.10871303 0.327220547
Q4 -0.062636562 0.474069546
Q1 0.00077821 0.379146354
Q2 -0.001540832 0.225913688
2016-
17 Q3 -0.072196621 0.283043181
Q4 0.012345679 0.178501758
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
-0.1
0
0.1
0.2
0.3
0.4
0.5
0.6
Chart Title
SLF return STDEV OF SLF
Figure 7Trade off chart
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It can be seen from chart given above that SLF return and standard deviation moves in different
direction and there is lack of trade off between risk and return. Trade off is the one of important
concept which reflect that if risk on asset is increasing then in that case return must also
increase. In same way if risk is declining on an asset then in that case return must also reduced
on same. It can be said that 50% of times trade off is not achieved in case of SLF as both risk and
return moves in inverse direction. However, in case of Q3 of 2013 to Q2 of 2015 trade off is
observed between both risk and return. It can be seen from chart that from Q4 to Q1 reutrn on
ETF increased and then at that time standard deviation also increased. After Q2 return on SLF
declined and standard deviation of same also reduced at fast rate. Trade off that exist between
risk and return comes to end in Q2 of 2015. After this time period again inverse trend comes in
existence.
1 2 3 4 5 6 7
-0.2
0
0.2
0.4
0.6
0.8
1
Chart Title
SLF return Beta
Figure 8Trade off chart with beta
In case SLF there is no presence of trade off between return and risk and it can be said on the
basis of above chart that trade off does not appear between return and risk. Beta value is
fluctuating but return is moving in specific direction (Baker, Bradleyand Wurgler, 2011). Hence,
here beta is not appearing as best measurement or tool to meausre trade off between risk and
return.
Best way to analyze risk and return trade off
Table 2Standard deviation and return
STW return STDEV OF
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