Sharpe Ratio

NeedThe ratio tells us about the how much excess return is investor getting for the riskier assets that is increasing the volatility of his portfolio. It is considered to compensate properly to the every risky venture a portfolio have in there. S(x)= (rx-Rf)/std dev(x) rx(return)the returns which investor is getting by the portfolio. It can take any frequency, and it should be normally distributed. Risk Free Return(Rf)This benchmark is only there to know if the investor is properly compensated for taking the risky return in the portfolio or not. Excess Return It is also known as the risk adjusted return as it is the return over the risk free return of the high volatile stocks. Std deviation Standard deviation is there to tell that what value it fluctuated against the risk free return. Using the sharpe Ratioit tells basically evaluates the performance of the portfolio with risk adjusted measure of return return in the mind. The manager A suppose have the return of 15% and B 12% but the deviation is higher that is 8% in the case of A with respect to B that is 5% , that signifies the total risk what manager have taken and the risk free rate is suppose 5% then A will have 1.25 and B would be having the return of the 1.4. It signifies that the B have more return on risk adjusted basis. Conclusion The idea of the ratio is to see how much additional return you are receiving for the additional volatility of holding the risky asset over a risk-free asset - the higher the better. Case for Omega ratio Volatility and risk are two different things and can not be considered as the same though they are most of the time. Not achieving threshold return means you are at loss. This is a manifestation of the inherent bias in regarding losses and gains as equally risky. Assumption of taking spread as the normal distribution is not correct.

Sortino ratio though removes penalization of the higher returns but dont give any information about the shape of the return distribution. Benefits of the Omega Its precise value is directly determined by each investors risk appetite. The quality of our investment bet relative to the return threshold. Omega allows us to compare different returns for different asset class and rank them according to their omegas. It requires no estimation of the higher moments. No hypothetical benchmark. Comparing the funds would be a exact as of because tailored benchmark that is loss threshold.

Treynor Ratio Treynor's objective was to find a performance measure that could apply to all investors, regardless of their personal risk preferences. He suggested that there were really two components of risk: the risk produced by fluctuations in the market and the risk arising from the fluctuations of individual securities SML(Security market line)-systematic risk or market risk versus return of the whole market at a certain time. Slope of the line is the Beta, that measures the relative volatility of the stock with respect to the market. The greater the line slope the better is the risk return trade off. X axis as the risk while y axis the expected return. Difference between the Treynor and Sharpe RatioThey actually do the same thing measuring the risk adjusted return but the Treynor uses Beta as the measure of the risk which is the market risk or systematic risk which cannot be nullify by the diversification instead it arises due to the business cycle , political situation or economic health of a country. While in the case of the Sharpe ratio the risk is measured by the standard deviation that is the total risk.

Information RatioActive Returns-total return on an actively managed portfolio over a period of time (rp) can be decomposed into the return on the passive benchmark (rb) plus active return Rp= rb + a. Active returns come from the return of the alpha generator and exposure to the alpha generator. Expected Utility Theory this is theory which indviduals needs to make choices that have uncertain outcomes. The theory says that individuals attitude towards taking the financial risk can be described by an increasing concave function that is utility function. Stutzer Indexthe manager is motivated enough to ensure that his average return do not fall below the benchmark. If the managers holds a portfolio by with an expected return greater than the expected return of the benchmark, the probability that the average return of the manager will fall below the benchmarks decays in an exponential rate with time. Since the manager would want to maximize this rate of decay of the underperformance approaches to zero exponentially with time. The decay rate is used as the a performance index. Higher the index good is the hedging.

OMEGA RATIOFor any return level r, the number (r) is the probability weighted ratio of gains to losses, relative to the threshold r. We may use the Omega functions calculated over a selected sequence of times to investigate the persistence or skill in a managers performance. The Omega function can also be used in portfolio construction Difference between the Sharpe ratio and OmegaTaking an example where we have two alpha generators A and B they both have the mean return of 2 with the varying standard deviation that is for A it is 3 and for B it is 6 respectively. Definitely if we consider the sharpe Ratio then A is preferable to B. however if we have rank them in accordance with the gain then the rank would be reversed. Now when we consider the Omega with our threshold r (return) that is 3 means the security providing the return lower than 3 would be considered as the loss, while above 3 return would be considered as the gain. When we will plot the probability distribution graph then we would notice that the B has more mass towards right of the graph then A.

Morning starIt uses Expected utility theory which they call it as the Morningstar Risk-Adjusted Return (MRAR). CRISILThe parameters are as follows on which crisil does the ratings of the fundsI. Superior return score-relative measure of risk and return for the scheme compared to their peer group. the SRS is calculated for a period of five years, with separate one year periods weighted differentially with the most recent period having the highest weightage. II. Mean Return and volatility- Mean return is the average of the daily return on Fund NAV while for the latest one year, while standard deviation is the Volatility measure. NOTESharpe Ratio is used. III. Portfolio concentration Analysis-Concentration measures the risk arising out of improper diversification. . Diversity Score is used as the parameter to measure Industry concentration and Company concentration for equity securities. IV. Liquidity Analysis-It measures the ease with which the portfolio can be liquidated. In case of Equities, liquidity is calculated by taking the average of last 3 months impact cost published by stock exchanges. V. VI. VII. Asset Quality-For debt securities. Modified Maturity/average Maturity-for debt securities. Downside Risk Probability(DRP)- Downside Risk Probability (DRP) DRP measures the probability of the investment getting lower returns than short tenor risk free securities. VIII. IX. Asset Size- for Ultra Short Term Debt and Liquid categories Tracking Error- Standard Deviation Icra Management Characteristics Operational procedure and control Regulatory compliance Portfolio credit quality Portfolio maturity Portfolio credit evaluation Moneycont

Lipper Rating System Salient Featuresi) Investor centred criteria ii)they are used in the conjunction with one another *global peer grouping is done on the basis of the metrics used are down belowThe highest 20% of funds in each peer group are named Lipper Leaders, the next 20% receive a rating of 4, the middle 20% are rated 3, the next 20% are rated 2, and the lowest 20% are rated 1. iii) mainly 4 criteria to rate-Total return -Consistent return -Preservation -Expenses Performance data utilised for Lipper Leaders are calculated using local currency. a) LIPPER RATING FOR TOTAL RETURN Risk is not taken into the while calculating this benchmark. Not good for the investor who want to avoid the downside risk. This may be combined with others for the better picture. NotesIt Use absolute return. b) LIPPER RATING FOR CONSISTENT RETURN it uses funds historical risk adjustment returns. Best for year on year basis. A Lipper Leader for Consistent Return in a volatile group is not good for the risk averse Notes-

Risk adjusted returns then only the ratios such as sharpe and treynor can be calculated They will give the best insight about the value to the risk taken by the fund manager. c) LIPPER RATING FOR PRESERVATION Historical loss avoidance relative to the other fund in the same group.

d) LIPPER RATINGS FOR EXPENSE Lipper Ratings for Expense reect funds expense minimisation relative to other funds within the same Lipper Global Classication.

This is best for the investors investors who want to their total cost and can be used in total conjunction with total return or consistent return in order to identify funds above average performance and lower than the average cost. Andreassteiner Impact CostImpact cost represents the cost of executing a transaction in a given stock, for a specific predefined order size, at any given point of time. Example-

We start by defining the ideal price as the average of the best bid and offer price, in the above example it is (3.5+4)/2, i.e. 3.75. In an infinitely liquid market, it would be possible to execute large transactions on both buy and sell at prices which are very close to the ideal price of Rs.3.75. In reality, more than Rs.3.75 per share may be paid while buying and less than Rs.3.75 per share may be received while selling. Such percentage degradation that is experienced vis-vis the ideal price, when shares are bought or sold, is called impact cost. Impact cost varies with transaction size.
Impact cost is a practical and realistic measure of market liquidity; it is closer to the true cost of execution faced by a trader in comparison to the bid-ask spread. In mathematical terms it is the percentage mark up observed while buying / selling the desired quantity of a stock with reference to its ideal price (best buy + best sell) / 2.