BUILDING SHARPE OPTIMIZATION STOCK PORTFOLIOS AND PERFORMANCE ANALYSIS.
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Transcript of BUILDING SHARPE OPTIMIZATION STOCK PORTFOLIOS AND PERFORMANCE ANALYSIS.
![Page 1: BUILDING SHARPE OPTIMIZATION STOCK PORTFOLIOS AND PERFORMANCE ANALYSIS.](https://reader035.fdocuments.net/reader035/viewer/2022070306/55163a21550346b2068b5054/html5/thumbnails/1.jpg)
BUILDING SHARPE OPTIMIZATION STOCK PORTFOLIOS AND PERFORMANCE ANALYSIS
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SCOPE OF PRESENTATION
• INTRODUCTION• SHARPE RATIO & OTHER PERFORMANCE
MEASURES• COMPARING PERFORMANCE MEASURES• METHODOLOGY ADOPTED• CONCLUSION • RECOMMENDATIONS
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NEED FOR PERFORMANCE ANALYSIS
• MUTUAL FUNDS THE MOST APPROPRIATE OPPORTUNITY FOR SMALL INVESTORS
• AS FINANCIAL MARKETS BECOME MORE COMPLEX & SOPHISTICATED , INVESTORS NEED A FINANCIAL INTERMEDIARY
• MODELS LIKE SHARPE PROVIDE PROFESSIONAL EXPERTISE ON SUCCESFUL INVESTING
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SHARPE RATIO
• The Sharpe ratio is a reward-to-risk ratio that focuses on total risk.
• It is computed as a portfolio’s risk premium divided by the standard deviation for the portfolio’s return.
p
fp
σ
RRratio Sharpe
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SHARPE RATIO FOR A LAYMAN
• IT QUANTIFIES THE RISK EFFICIENCY OF AN INVESTMENT
• EQUAL TO EFFECTIVE RETURN(ACTUAL RETURN MINUS RISK FREE RATE) OF AN INVESTMENT DIVIDED BY STANDARD DEVIATION
• A HIGH SHARPE RATIO SIGNALS AN INVESTMENT WITH GREATER RISK EFFICIENCY AND IS DESIRABLE
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OTHER PERFORMANCE MEASURES
The Treynor Ratio• The Treynor ratio is a reward-to-risk ratio that
looks at systematic risk only.• It is computed as a portfolio’s risk premium
divided by the portfolio’s beta coefficient.
p
fp
β
RRratio Treynor
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OTHER PERFORMANCE MEASURESJensen’s Alpha• Jensen’s alpha is the excess return above or below the security market
line. It can be interpreted as a measure of how much the portfolio “beat the market.”
• It is computed as the raw portfolio return less the expected portfolio return as predicted by the CAPM.
Actual return
CAPM Risk-Adjusted ‘Predicted’ Return“Extra” Return
RREβ R Rα fMpfpp
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Comparing Performance Measures, I.
• Because the performance rankings can be substantially different, which performance measure should we use?
Sharpe ratio:
• Appropriate for the evaluation of an entire portfolio.
• Penalizes a portfolio for being undiversified, because in general, total risk systematic risk only for relatively well-diversified portfolios.
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Comparing Performance Measures, II.
Treynor ratio and Jensen’s alpha:
• Appropriate for the evaluation of securities or portfolios for possible inclusion into an existing portfolio.
• Both are similar, the only difference is that the Treynor ratio standardizes returns, including excess returns, relative to beta.
• Both require a beta estimate (and betas from different sources can differ a lot).
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Sharpe-Optimal Portfolios, I.• Allocating funds to achieve the highest possible Sharpe ratio is said to be
Sharpe-optimal.
• To find the Sharpe-optimal portfolio, first look at the plot of the possible risk-return possibilities, i.e., the investment opportunity set.
ExpectedReturn
Standard deviation
××
××
×
×
××
×
×
×× ×
×
×
×
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ExpectedReturn
Standard deviation
× A
Rf
A
fA
σ
RREslope
Sharpe-Optimal Portfolios, II.• The slope of a straight line drawn from the risk-free rate to where the
portfolio plots gives the Sharpe ratio for that portfolio.
• The portfolio with the steepest slope is the Sharpe-optimal portfolio.
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Sharpe-Optimal Portfolios, III.
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METHODOLOGY ADOPTED
• CALCULATION OF ALL THE COMPOSITE PERFORMANCE MEASUREMENT RATIOS
• RANKING THE SELECTED 24 MUTUAL FUNDS AS PER THE RATIOS OBTAINED
• APPLICATION OF SHARPE OPTIMIZATION TECHNIQUE TO KOTAK 30 EQUITY GROWTH MUTUAL FUND
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RANKING OF SAMPLE MUTUAL FUNDS ON BASIS OF TREYNOR RATIO
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RANKING OF SAMPLE MUTUAL FUNDS ON BASIS OF TREYNOR RATIO
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RANKING OF SAMPLE MUTUAL FUNDS ON BASIS OF JENSON RATIO
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RANKING OF SAMPLE MUTUAL FUNDS ON BASIS OF SHARPE RATIO
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ORIGINAL ASSET ALLOCATION FOR KOTAK 30 GROWTH SCHEME
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RESULTS OF SHARPE OPTIMISATION FOR KOTAK 30 GROWTH SCHEME
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CONCLUSION
• SHARPE RATIO IS A BLUNT INSTRUMENT TO MEASURE RISK ADJUSTED RETURN
• IT PRESENTS A MORE COMPLETE PICTURE OF FUND PEFORMANCE THAN RAW RETURN
• IT HELPS INVESTORS EVALUATE RELATIVE SUCCESS OF COMPETING FUNDS FOLLOWING THE SAME BROAD INVESTMENT STRATEGIES
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RECOMMENDATIONS
• WELL KNOWN PORTFOLIOS CAN HAVE IMPROPER DESIGNS TOO
• A GOOD FUND MANAGER SHOULD NOT RELY ON A SINGLE MEASURE FOR DESIGNING A PORTFOLIO
• FINALLY ,EVALUATION OF A FUND MANAGER SHOULD BE DONE MANY TIMES OVER DIFFERENT MARKET ENVIRONMENT
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“It is not the return on my investmentthat I am concerned about.
It is the return of my investment!”
– Will Rogers