Portfolio Performance Measure some techniques by Binam Ghimire

Portfolio Performance Measure – some techniques by Binam Ghimire

Objectives q. Discussion on the topics of: q. Portfolio Performance Evaluation q. Raw Return Analysis q. Risk Adjusted Return Techniques: Sharpe Ratio, Treynor Ratio, Jensen Alpha, M 2, Information Ratio, Tracking Error, Modified Sharpe q. Attribution Analysis q. Measuring performance with multiple risk factors 2

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Portfolio Managers q. High Returns: Above Average q. Low Risk: Eliminate unique risk (diversify) q. Outperformance q Superior Timing q Superior Selection q French, K. R. (2008). Presidential address: The cost of active investing. The Journal of Finance, 63(4), 1537 -1573. q. Why is it difficult to beat the benchmark? 4

Portfolio Managers q Boxplot diagram for peer group comparison q Diamond for average return of fund manager q Square for Benchmark average return 5

Raw Returns q. Arithmetic, Geometric, annualizing, HPR, single period, multiple periods, other sub periods. . . q. Statistically significant results 6

Composite Portfolio Performance Measures q. Treynor Portfolio Performance Measure q. Sharpe Portfolio Performance Measure q. Jensen Portfolio Performance Measure q. Information Ratio Performance Measure 7

Treynor Ratio q. Jack Treynor (1965) q. The ratio of Portfolio excess return to b Treynor, J. L. (1965). How to rate management of Investment Funds. Harvard Business Review, 43 (1), 63 -75. 8

Sharpe Ratio q. William Sharpe (1966) q. The ratio of Portfolio excess return to s Sharpe, W. F. (1966) Mutual fund performance. The Journal of Business, 39(1), 119 -138. 9

Jensen Measure q Michael C Jensen 1968 q It is portfolio alpha, AKA Jensen alpha =(total portfolio return – risk free rate) – [portfolio beta x (market return – risk free rate)] OR = (Rp – Rf) – [βp x (Rm – Rf)] q A measure of portfolio performance that uses the portfolio Beta and CAPM to calculate its excess return which can be positive, negative or zero Jensen, M. C. (1968). The performance of mutual funds in the period 1945– 1964. The Journal of finance, 23(2), 389 -416 10

Information Ratio q. Jack Treynor and Fisher Black in 1973 q. Ratio of alpha to the standard deviation of diversifiable risk q. Denominator is TE Treynor, J. L. , & Black, F. (1973). How to use security analysis to improve portfolio selection. The journal of business, 46(1), 66 -86. 11

Modigliani and Modigliani q. Leah Modigliani and Franco Modigliani, 1997 Modigliani, F. , & Leah, M. (1997). Risk-adjusted performance. Journal of Portfolio Management, 23 (2), 45 -54. 12

Performance Measurement with Downside Risk • 13

Modified Sharpe Ratio q. Israelson (2005) MSR = ER/SD(ER/abs. ER) Israelsen, C. (2005). A refinement to the Sharpe ratio and information ratio. Journal of Asset Management, 5(6), 423427. 14

Performance Attribution Analysis • 15

Measuring Performance with Multiple Risk Factors • q. Applying the Jensen measure q. Alphas can be calculated relative to three – four – five … factors q. Style-like analysis 16