Portfolio Yield can be defined as the percentage of investment income over the pool’s invested asset portfolio. This ratio is a metric that is commonly used by banks, or microfinance banks to measure the average income that the company receives from the loans. This is mostly calculated on the average of the total loan portfolio.
This ratio can further be broken down into several categories, including loan size, and investor wide analysis for a detailed analysis. This is resourceful when the management uses this as an indication of the pricing strategy for every relevant type of loan portfolio.
Therefore, this tool is considered as a highly resourceful tool that measures the extent to which a company has an advantage, or a disadvantage in terms of earnings (on investments), as compared to other players in the market. The company uses this information in order to decide if they should increase or decrease the interest and the fee on the new loans after having compared it with the industry average.
Portfolio Yield Formula
Portfolio Yield can be calculated using the following formula:
Portfolio Yield = Interest and Fee Income derived from loan / Average Gross loan portfolio
Interest and fee income from the loan includes all interest and fees, as well as penalty income that the company receives from the late payment.
On the other hand, the average gross loan portfolio includes the gross loan portfolio at a given date, plus the loan portfolio at the end of the second period, divided by 2.
Interpretation of Portfolio Yield
Generally speaking, a higher portfolio yield is considered to be more attractive from the perspective of investors. This is because higher yields imply that additional expected yield comes with higher volatility in the investment process. This means that there is a potentially higher loss of investment in any given year. Therefore, in accordance with the risk-return formula, it can be seen that higher risks are indicative of higher returns.
Hence, the portfolio yield that is higher as compared to other averages implies that the overall risk appetite of the investor is high. Hence, the portfolio as a whole might be prone to higher losses. On the contrary, if the portfolio yield is somewhat mediocre, this implies that the portfolio is not as risky.
Therefore, portfolio yield is mainly used in comparison with other yields, since the standalone value of portfolio yield might not be much resourceful. Hence, if portfolio yield is high, it implies a higher risk on the part of the company. If the portfolio yield is low, it implies of a relatively lower risk portfolio.
To summarize, it can be seen that high portfolio yields have the following implications:
- High risk portfolios – this indicates of a possibility that the company has taken on a higher risk, and hence, they are then deriving higher returns.
- Effective portfolio management – Higher portfolio yields also mean that companies have managed a better portfolio management, using which they are able to generate better results for the company.
On the contrary, it can be seen that low portfolio yields imply the following:
- Low risk portfolios – low portfolio yields also mean that companies are risk averse, and therefore, they are not as exposed to risk as they were previously.
- Ineffective portfolio management – Lower portfolio yields also mean that companies are not as effective in managing their portfolios, and therefore, their portfolio yield is not as high as it should be.
Portfolio Yield Example
The concept of portfolio yield is illustrated as follows:
Julie Inc. is a microfinance company, with the following balances as at 31st December 2019. They have the following balances at year-end:
| Particular | Amount |
| Interest Income | $500,000 |
| Fee Income | $750,000 |
| Gross Loan Portfolio as at 31st December 2019 | $15,000,000 |
| Gross Loan Portfolio as at 31st December 2018 | $12,500,000 |
Interest Fee and Income from Loan = $500,000 + $750,000 = $ 1,250,000
Average Loan Portfolio = $15,000,000 + $12,500,000 = $27,500,000 /2 = $13,750,000
Portfolio Yield = Interest and Fee Income derived from loan / Average Gross loan portfolio
Portfolio Yield = 1,250,000/13,750,000 = 9.1%
This implies that the average return that is yielded by the investment is equivalent to 9.1%.
This is used in conjunction with the other portfolio yields in the industry. For example, the average industry yield in the market is equivalent to 15%. This implies that the portfolio created by Julie Inc. renders a lower return as compared to other market averages. This might also mean that Julie Inc. is relatively risk-averse (in accordance with the risk-return paradigm), or a particular investment in the portfolio is generating low results.
In this aspect, it is also important to note the fact that portfolio yield trajectory over the course of time indicates how well the fund is being managed. A positive trajectory shows that the investments are solid, and are generating positive returns. On the contrary, if the portfolio yield decreases over the course of time, it implies that the fund is not generating positive results.
