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Measures of Portfolio Performance

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Measures of Portfolio Performance Measuring returns If a fund manager is generating high returns, pay only for alpha Returns should be risk adjusted – PowerPoint PPT presentation

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Title: Measures of Portfolio Performance


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

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 managers
    control
  • Consider the next slide

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 _at_ 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
    _at_1.25M each
  • At the end of the period, each is worth 13M/14
    or .93M
  • Unitized return on the portfolio is 7

4
An example
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

6
Risk Adjusted Measures of Portfolio Performance
  • Sharpe Ratio
  • M2
  • Jensens Alpha
  • Treynors Ratio

7
An Example Using the 4 Measures
8
Which Measures to Use?
  • For compensating fund managers
  • Jensens 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
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