Performance Evaluation Measures of Portfolio

8/3/2019 Performance Evaluation Measures of Portfolio

http://slidepdf.com/reader/full/performance-evaluation-measures-of-portfolio 1/16

Portfolio Evaluation & Revision

SAIM (UNIT IV)

Presented by:-

Dr. Mini Jain



It is Not the Return On My Investment ...

“It is not the return on my investment that I am concerned about.

It is the return of my investment!”

– Will Rogers



Introduction

• Portfolio evaluating refers to the evaluation of the performance of the portfolio. It isessentially the process of comparing the return earned on a portfolio with the returnearned on one or more other portfolio or on a benchmark portfolio. Portfolio evaluationessentially comprises of two functions, performance measurement and performanceevaluation.

• Performance measurement is an accounting function which measures the return earnedon a portfolio during the holding period or investment period.

• Performance evaluation , on the other hand, address such issues as whether the

performance was superior or inferior, whether the performance was due to skill or luck etc.

• The ability of the investor depends upon the absorption of latest developments whichoccurred in the market. The ability of expectations if any, we must able to cope up withthe wind immediately. Investment analysts continuously monitor and evaluate the resultof the portfolio performance. The expert portfolio constructer shall show superiorperformance over the market and other factors. The performance also depends upon thetiming of investments and superior investment analysts capabilities for selection.

• The evolution of portfolio always followed by revision and reconstruction. The investorwill have to assess the extent to which the objectives are achieved. For evaluation of portfolio, the investor shall keep in mind the secured average returns, average or belowaverage as compared to the market situation. Selection of proper securities is the firstrequirement.



Need for portfolio evaluation

• To build an optimum portfolio & to ensure that the

portfolio continues to remain an optimum one.

• Performance evaluation of the portfolio is required to be

done at periodic intervals to check up whether the

objectives of the portfolio are being met

• To revise the portfolio if required



Performance Evaluation

MeasuresFor evaluation the performance of the

portfolio(s), it is necessary to consider both risk

& return.

Various methods to do so:

Sharpe measure.

Treynor measure.

Jenson measure.



Sharpe Measures

- William Sharpe

The objective of modern portfolio theory is maximization of return orminimization of risk. In this context the research studies have tried toevolve a composite index to measure risk based return. The credit forevaluating the systematic, unsystematic and residual risk goes to sharpe,Treynor and Jensen.

Sharpe measure total risk by calculating standard deviation. The methodadopted by Sharpe is to rank all portfolios on the basis of evaluationmeasure. Reward is in the numerator as risk premium. Total risk is in thedenominator as standard deviation of its return. We will get a measure of portfolio’s total risk and variability of return in relation to the risk premium.

The Sharpe ratio is a reward-to-risk ratio that focuses on total risk.One simple way to investigate the fund’s performance is to considerrisk-adjusted returns…. Thus, the Sharpe measure gives us a measure of return per unit of totalrisk.



Sharpe Measures

R p – Average rate of return on portfolio p.

R f –

Average rate of return on a risk-free investment.

p – S.D. of return of portfolio p.

Hence, the Sharpe measure reflects the excess

return earned on a portfolio per unit of its total risk

(standard deviation).

The higher the Sharpe measure, the better the

performance.

p

f p

σ

R R

ratioSharpe



Treynor Measures

- Jack TreynorThe Treynor ratio is a reward-to-risk ratio that

looks at systematic risk only.

It basically gives us a measure of return per unitof market risk (or systematic risk) that our

investment earns.

This measure substitutes standard deviation forBeta.

However, unlike the Sharpe Ratio, it uses the

systematic risk instead of total risk.



Treynor Measures

R p – Average rate of return on portfolio p.

R f –

Average rate of return on a risk-free investment.β p – Beta[systematic risk] of portfolio p.

Hence this measure reflects the excess return on a

portfolio to the portfolio beta.As systematic risk is the measure of risk, the

Treynor measure implicitly assumes that the

portfolio is well diversified.

p

f p

R R

βratioTreynor



Jensen’s Measure:

- Michael Jensen• Jensen attempts to construct a measure of

absolute performance on a risk adjusted

basis. This measure is based on CAPMmodel. It measures the portfolio manager’spredictive ability to achieve higher returnthan expected for the accepted riskiness.

The ability to earn returns throughsuccessful prediction of security prices on astandard measurement.



Jensen’s Measure

• E(Rp) = Rf + βp (Rm – Rf )

• Where,

• Rp = Return on portfolio

• RM = Return on market index

• Rf = Risk free rate of return• βp = Beta coefficient of the portfolio



Application of Portfolio

Performance Measures• Calculated Sharpe, Treynor and Jenson measures for 20

mutual funds. Using the Jenson measure, only 3 managershad superior performance (Fidelity Magellan, Templeton

Growth Funds, and Value Line Special Situations Fund)while 2 managers had inferior performance (OppenheimerFund and T. Rowe Price Growth Stock Fund).



Relationship among Portfolio

Performance Measures• For all three methods, if we are examining a well-

diversified portfolio, the rankings should be similar. Arank correlation measure finds that there is about a 90%correlation among all three measures. Reilly recommendsthat all three measures. [In my opinion the Jensen measureis the most stringent. It is testing for statistical significance,whereas the other methods are not. The other methods arealso examining average returns, whereas the Jensenmeasure uses actual returns during each observation

period.]



Thank You!!!

Performance Evaluation Measures of Portfolio

Documents

Transcript of Performance Evaluation Measures of Portfolio