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PORTFOLIO PERFORMANCE MEASUREMENT

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... should we have expected, for the same level of risk, from a ... ADJUSTING TO MARKET RISK. TREYNOR MEASURE. Compare portfolio risk premium to systematic risk ... – PowerPoint PPT presentation

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Title: PORTFOLIO PERFORMANCE MEASUREMENT


1
PORTFOLIO PERFORMANCE MEASUREMENT
  • If we are paying an active manager to provide
    superior performance, how can we be sure we are
    getting what we pay for?
  • Techniques
  • Risk-adjusted measures
  • Market-timing measures
  • Performance attribution and style analysis

2
RISK-ADJUSTED MEASURES
  • What return should we have expected, for the same
    level of risk, from a manager with no particular
    skill?
  • Did our manager do better than this?
  • Whats the relevant measure of risk?
  • Whats the relevant benchmark portfolio?

3
SHARPE MEASURE
  • Compare portfolio risk premium to total risk
  • Equal to slope of Capital Allocation Line
  • Need a benchmark market portfolio?

4
MODIGLIANI MEASURE
  • Portfolio risk may be different from benchmark
    risk
  • What would managed portfolio risk premium have
    been if we had levered or unlevered to benchmark
    risk?

5
ADJUSTING TO MARKET RISK
6
TREYNOR MEASURE
  • Compare portfolio risk premium to systematic risk
  • Potentially misleading for a portfolio with
    substantial unsystematic risk

7
JENSENS ALPHA
  • Alpha is a measure of excess return relative to
    CAPM standard
  • Again, watch for unsystematic risk
  • Ease of regression application

8
APPRAISAL RATIO
  • Compare alpha to residual risk
  • Watch out for differences in systematic risk
  • Could be useful for comparing active portfolios

9
BEFORE- OR AFTER-THE-FACT MEASUREMENT?
  • The theory behind risk-adjusted performance
    measures calls for before-the-fact measurement
  • What are the data-gathering problems in
    before-the-fact measurement?
  • In practice, were stuck with after-the fact data
  • Luck vs. skill problem of statistical power

10
A PROBLEM WITH AFTER-THE-FACT MEASUREMENT
  • According to our estimate of alpha, the manager
    in the example looks good. But why?
  • Good stock picker?
  • Good market timer?
  • Market-timing ability is hard to detect with
    Jensens alpha

11
SUCCESSFUL MARKET TIMINGAND MISLEADING ALPHA
12
TESTING FOR MARKET TIMINGTREYNOR-MAZUY
13
TESTING FOR MARKET TIMINGHENRIKSSON-MERTON
14
PERFORMANCE ATTRIBUTIONANALYSIS
  • For each asset class i
  • Benchmark weights
  • Benchmark returns
  • Portfolio weights
  • Portfolio weights

15
DECOMPOSING PERFORMANCE
16
PERFORMANCE ATTRIBUTIONCOMPONENTS
  • Asset allocation contribution
  • Security selection contribution
  • Interaction

17
STYLE ANALYSIS
  • Define the managers style in terms of
    benchmark portfolios (e.g., asset classes)
  • Regress managed portfolio returns against
    benchmark returns
  • Fitted values from the regression are the
    managers style-adjusted expected returns
  • Residual (tracking error) is the measure of
    superior performance

18
EXAMPLE OF STYLE ANALYSIS
19
THE PORTFOLIO MANAGEMENT PROCESS
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