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Evaluating Portfolio Performance. Two key points: Evaluation must account for risk Total return of assets under management matters Measuring return: Dollar weighted return = IRR Time weighted return = arithmetic average. Risk adjusted performance measures: The Big 3. Sharpe measure (S):
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Evaluating Portfolio Performance • Two key points: • Evaluation must account for risk • Total return of assets under management matters • Measuring return: • Dollar weighted return = IRR • Time weighted return = arithmetic average
Risk adjusted performance measures: The Big 3 • Sharpe measure (S): • (rp - rf ) / p • Risk premium per unit of total risk • Appropriate for evaluating entire investment portfolio • Evaluates manager’s ability to diversify unsystematic risk
Risk adjusted performance measures: The Big 3 • Treynor (T) • (rp - rf ) / bp • Risk premium per unit of systematic risk • Appropriate for evaluating subsets of securities within a portfolio • Assumes subset is part of a well diversified portfolio
Risk adjusted performance measures: The Big 3 • Jensen’s Alpha (a) • ap = rp - [rf + bp(rm - rf )] • Absolute CAPM risk adjusted performance • Appropriate for evaluating an actively managed portfolio • Can be converted into Appraisal Ratio: • ap / sep
