Chapter 20. Active Management and Performance Measurement. Chapter Summary. Objective: To introduce the most widespread approaches to risk adjustment for performance evaluation. Introduction The Conventional Theory of Performance Evaluation Market Timing. The Objective of Active Management.
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Active Management and Performance Measurement
Are markets totally efficient?
What is abnormal?
Abnormal performance is measured:
E (rp-rf) / p
Appraisal Ratio = ap / s(ep)
Appraisal Ratio divides the alpha of the portfolio by the nonsystematic risk
Nonsystematic risk could, in theory, be eliminated by diversification
Managed Portfolio: return = 35% st dev = 42%
Market Portfolio: return = 28% st dev = 30%
T-bill return = 6%
30/42 = .714 in P (1-.714) or .286 in T-bills
(.714) (.35) + (.286) (.06) = 26.7%
Since this return is less than the market, the managed portfolio underperformed
It depends on investment assumptions
1) If the portfolio represents the entire investment for an individual, Sharpe Index compared to the Sharpe Index for the market.
2) If many alternatives are possible, use the Jensen or the Treynor measure
The Treynor measure is more complete because it adjusts for risk
Adjusting portfolio for up and down movements in the market