Fatima Tahir

BB-13-39
Chapter 22
EVALUATION OF INVESTMENT
PORTFOLIO PERFORMANCE
Chapter sequence

Evaluation the Portfolio performance

Bottom line issues
Risk adjustment methods
Style investing
Performance presentation standards
Issues In evaluating portfolio performance

Performance measure issue

Composite measure of performance
Performance attribution and style analysis
Portfolio presentation standards
 Performance must be evaluated before
answering these questions

Is the return after all expenses adequate

compensation for the risk?
How much risk did the investor will take?
What return should have been earned on the
portfolio?
Benchmark portfolio must be legitimate alternative
that reflects objectives
Return Measures

Change in investors total wealth over an

evaluation period
(VE - VB) / VB
VE =ending portfolio value
VB =beginning portfolio value
Assumes no funds added or withdrawn during
evaluation period
Dollar weighted returns (DWR)

Captures cash flows during the evaluation period

Equivalent to internal rate of return

Equates all the cash flows including ending market value with
the beginning market value of the portfolio
MISLEADING MEASURE
A PORTFOLIO manager begins with 1000$ halfway through the
year client withdraw 200$ and at the end of year portfolio
performance will be 910.
Investor will not decrease the value of portfolio by 90 or 10%
Time weighted returns (TWR)

Captures cash flows during the evaluation period and

permits comparisons with benchmarks
Calculate a return relative for each time period defined
by a cash inflow or outflow
Use each return relative to calculate a compound rate of
return for the entire period
CALCULATION OF TWR
Investment at the beginning of the year =500000
At the end of year=545000
At the end of year 2 the client give the manager 55000 the value of
portfolio is= 630000 what is the TWR
During the year 1= 545,000-500,000/500,000=9%
During the year 2=630,000-600000/600,000=5%,
TWR= (1.09)(1.05)-1=14.45%
Annualized TWR={(1.09)(1.05)}*1/2=1.0698-1=6.98%
Dollar- and Time-weighted Returns can give
different results

Dollar-weighted returns appropriate for portfolio owners

Time-weighted returns appropriate for portfolio managers
RISK CONSIDERATION
Risk differences cause portfolios to respond differently to market
changes
Total risk measured by the standard deviation of portfolio
returns
Non diversifiable risk measured by a securitys beta.
COFFICIENT OF DETERMINATION R2

IF R square is =1 (more diversified) funds returns explains the

market returns
PERFORMANCE UNIVERSE
Constructed by aggregating market valuation and income accruals for a
large number of portfolios that are managed individually
PERFORMANE BENCHMARK
Unmanaged passive portfolio that reflects a managers investment style
ALL SHOULD BE
UNAMBIGIOUS SPECIFIED IN ADVANCE
APPROPRIATE INVESTABLE
MEASURABLE
Risk-Adjusted Performance

The Sharpe reward-to-variability ratio

Benchmark based on the ex post capital market line
RVAR TR p RF /SDp
=Average excess return / total risk
Risk premium per unit of risk
The higher, the better the performance
Provides a ranking measure for portfolios
S & P 500
Mutual funds Average returns SD BETA R2
DREFUS GROWTH 15.86 22.85 1.46 .64
LVY GROWTH 18.10 13.44 .96 .79
KEMPER GROWTH 18.59 21.68 1.45 .69
MAGELLAN 22.09 17.27 1.24 .79
WINDSOR 18.39 11.82 .60 .39
RF 7.96
Risk-Adjusted Performance

The Treynor reward-to-volatility ratio

Distinguishes between total and systematic risk
RVOL TR p RF /p
=Average excess return / market risk
Risk premium per unit of market risk
The higher, the better the performance
Implies a diversified portfolio
RVAR or RVOL?

Depends on the definition of risk

If total (systematic) risk best, use RVAR (RVOL)
If portfolios perfectly diversified, rankings based on either
RVAR or RVOL are the same
Differences in diversification cause ranking differences
RVAR RVOL
.35 5.40
.75 10.54
.49 7.33
.82 11.42
.88 17.38
Jensens Alpha
The estimated a coefficient in
Rpt - RFt =ap +bp [RMt - RFt] +ept
is a means to identify superior or inferior portfolio performance
CAPM implies a is zero
Measures contribution of portfolio manager beyond return
attributable to risk
If a >0 (<0,=0), performance superior (inferior, equals) to
market, risk-adjusted
M-squared Measure
Problem: RVAR and RVOL measures not in
percentage terms
M-squared is return earned if portfolio's total risk
either dampened or leveraged to match the
benchmark total risk
Hypothetical riskless borrowing or lending required to
make risk adjustment
Rank portfolios according to adjusted returns
M-squared = RF + [Rp RF] (m/p)
Style analysis and performance attribution
STYLE BOX (NINE CELLS)
A classification reflecting a portfolio managers
style characteristics
PERFORMANCE ATTRIBUTION
MARKET TIMINGS
SECURITY SELECTION
 PERFORMANCE PRESENTATION STANDARDS

AIMR ASSOCIATION (ASSOCIATION FOR INVESTMENT MANAGEMENT

AND RESEARCH)
MINIMUM STANDARDS FOR PRESENTING PERFORMANCE STANDARDS
IT SHOULD BE FAIR.
IT SHOULD ENSURE UNIFORMATITY