PORTFOLIO
PERFORMANCE
EVALUATION
1
Issues in performance measurement
2 Rules
Traditional performance measures
Dollar/ Rupee weighted Performance
Measures
2
MEASURES OF RETURN
ISSUES IN MEASURES OF RETURN
complicated by addition or withdrawal of money
by the investor
percentage change is not reliable when the base
amount may be changing
timing of additions or withdrawals is important to
measurement
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PERFORMANCE MEASURES
Bank Administrative Institute Report, 1968
Performance based on actual returns.
Performance based on market value
Portfolio manager’s performance should consider
risk also
Cannot compare among funds operating under
different conditions
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2 RULES
1. Arithmetic Mean is not a useful statistic
2. Rupees are more important than
percentages.
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ARITHMETIC V. GEOMETRIC
AVERAGES
GEOMETRIC MEAN FRAMEWORK
GM = (Π HPR)1/N - 1
where Π = the summation of the
product of
HPR= the holding period returns
n= the number of periods
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ARITHMETIC V. GEOMETRIC
AVERAGES
ARITHMETIC MEAN FRAMEWORK
provides a good indication of the expected rate
of return for an investment during a future
individual year
it is biased upward if you attempt to measure
an asset’s long-run performance
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ARITHMETIC V. GEOMETRIC
AVERAGES
GEOMETRIC MEAN FRAMEWORK
measures past performance well
represents exactly the constant rate of return
needed to earn in each year to match some
historical performance
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Why Rupees are more
important ?
2 funds earned 44% and 12%
Average rate of return 28% ?
44% return on fund of 2,50,000
12% return on fund of 400,00,000
Average return is
(0.9938*12%) + (0.0062*44%) = 12.10%
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Traditional Measures
NAV change
NAV change with index
NAV yield
Sharpe’s Performance Measure
Treynor’s Performance Measure
Jensen’s Measure
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NAV Based Measures
NAV change over the investment period.
NAV Yield (NAVt+Dt / NAVt-1 - 1)*100
NAV change with index
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THE USE OF MARKET INDICES
INDICES
are used to indicate performance but depend
upon
the securities used to calculate them
the calculation weighting measures
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RISK-ADJUSTED MEASURES OF
PERFORMANCE
THE REWARD TO VOLATILITY RATIO
(TREYNOR MEASURE)
THE REWARD TO VARIABILITY (SHARPE
RATIO)
THE JENSEN MEASURE OF PORTFOLIO
PERFORMANCE
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TREYNOR MEASURE
THE REWARD TO VOLATILITY RATIO
There are two components of risk
risk associated with market fluctuations
risk associated with the stock
Characteristic Line (ex post security line)
defines the relationship between historical portfolio
returns and the market portfolio
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TREYNOR MEASURE
TREYNOR MEASURE
Formula
arp − ar f
RVOL p =
βp
where arp = the average portfolio return
arf = the average risk free rate
β p = the slope of the characteristic
line during the time period
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TREYNOR MEASURE
THE CHARACTERISTIC LINE
arp SML
β p
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THE SHARPE RATIO
THE REWARD TO VARIABILITY (SHARPE
RATIO)
measure of risk-adjusted performance that uses a
benchmark based on the ex-post capital market
line
total risk is measured by σ
p
indicates the risk premium per unit of total risk
uses the Capital Market Line in its analysis
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THE SHARPE RATIO
SHARPE RATIO
formula:
ar p − ar f
SR p =
σp
where SR = the Sharpe ratio
σ p= the total risk
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THE SHARPE RATIO
arp CML
σ p
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THE JENSEN MEASURE OF
PORTFOLIO PERFORMANCE
BASED ON THE CAPM EQUATION
E (ri ) = RFR + β [ E (rm ) − RFR ]
measures the average return on the portfolio over
and above that predicted by the CAPM
given the portfolio’s beta and the average market
return
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THE JENSEN MEASURE OF
PORTFOLIO PERFORMANCE
THE JENSEN MEASURE
known as the portfolio’s alpha value
recall the linear regression equation
y=α +β x+e
alpha is the intercept
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COMPARING MEASURES OF
PERFORMANCE
TREYNOR V. SHARPE
SR measures uses σ as a measure of risk while Treynor uses β
SR evaluates the manager on the basis of both rate of return
performance as well as diversification
Sharpe measures is for portfolios only where as Treynor’s measure
can be used for portfolios as well as single securities.
for a completely diversified portfolio
SR and Treynor give identical rankings because total risk is really
systematic variance
any difference in ranking comes directly from a difference in
diversification
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MEASURES OF RETURN
In case of cash with drawls and cash deposits :
Dollar-Weighted Returns
uses discounted cash flow approach
weighted because the period with the
greater number of withdrawals or deposits or
transaction of shares has a greater influence
on the overall average
Also known as IRR
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CALCULATION
Value days return Annualized return Rupee
Weighted
average return
Annualized return = return * 365 / days
Dollar Weighted average return = value * Annualized return / total value
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