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Evaluating Portfolio Performance. Two key points: Evaluation must account for risk Total return of assets under management matters Measuring return: Dollar weighted return = IRR Time weighted return = arithmetic average. Risk adjusted performance measures: The Big 3. Sharpe measure (S):

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evaluating portfolio performance
Evaluating Portfolio Performance
  • Two key points:
    • Evaluation must account for risk
    • Total return of assets under management matters
  • Measuring return:
    • Dollar weighted return = IRR
    • Time weighted return = arithmetic average
risk adjusted performance measures the big 3
Risk adjusted performance measures: The Big 3
  • Sharpe measure (S):
    • (rp - rf ) / p
    • Risk premium per unit of total risk
    • Appropriate for evaluating entire investment portfolio
    • Evaluates manager’s ability to diversify unsystematic risk
risk adjusted performance measures the big 31
Risk adjusted performance measures: The Big 3
  • Treynor (T)
    • (rp - rf ) / bp
    • Risk premium per unit of systematic risk
    • Appropriate for evaluating subsets of securities within a portfolio
    • Assumes subset is part of a well diversified portfolio
risk adjusted performance measures the big 32
Risk adjusted performance measures: The Big 3
  • Jensen’s Alpha (a)
    • ap = rp - [rf + bp(rm - rf )]
    • Absolute CAPM risk adjusted performance
    • Appropriate for evaluating an actively managed portfolio
    • Can be converted into Appraisal Ratio:
      • ap / sep
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