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Measures of Portfolio Performance

Measures of Portfolio Performance. Measuring returns If a fund manager is generating high returns, pay only for alpha Returns should be risk adjusted Should not pay for adding additional risk Compare to pre-established benchmarks. Asset and Portfolio Returns.

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Measures of Portfolio Performance

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  1. Measures of Portfolio Performance • Measuring returns • If a fund manager is generating high returns, pay only for alpha • Returns should be risk adjusted • Should not pay for adding additional risk • Compare to pre-established benchmarks Intermediate Investments F305

  2. Asset and Portfolio Returns • Find the HPR for and asset or portfolio of assets • Find the optimal portfolio and compare to the HPR of a portfolio that is equal or value weighted • When measuring a managed portfolio, must adjust for inflows and outflows beyond the manager’s control • Consider the next slide Intermediate Investments F305

  3. An example • Suppose we are computing the two month return on a managed portfolio worth $10M to start • After 1 month, the portfolio has grown to $12.5M ad $5M in new contributions are added making the portfolio now worth $17.5M • After 2 months, the portfolio has shrunk to $13M • Compute the unitized returns • Think of the initial portfolio as 10 units @ $1M each • A fictional unit is worth $1.25M after one month • The $5M cash injection buys 4 more units • After the cash injection there are 14 units @$1.25M each • At the end of the period, each is worth $13M/14 or $.93M • Unitized return on the portfolio is –7% Intermediate Investments F305

  4. An example Intermediate Investments F305

  5. An example (cont) • Which fund has performed better, A or B? MEASURES OF THE MEANS • Arithmetic averages are best used to predict future performance • Geometric averages are required to be used by Mutual Funds to show historical performance Intermediate Investments F305

  6. Risk Adjusted Measures of Portfolio Performance • Sharpe Ratio • M2 • Jensen’s Alpha • Treynor’s Ratio Intermediate Investments F305

  7. An Example Using the 4 Measures Intermediate Investments F305

  8. Which Measures to Use? • For compensating fund managers • Jensen’s Alpha – how much excess return over and above the expected return based on the SML • For Optimal Portfolio Choice • Sharpe ratio when the portfolio represents the entire investment fund • The Treynor ratio when the portfolio represents one sub-portfolio out of many that are added together to make a passive portfolio Intermediate Investments F305

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