PORTFOLIO

PERFORMANCE
EVALUATION

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 Issues in performance measurement
 2 Rules
 Traditional performance measures
 Dollar/ Rupee weighted Performance
Measures

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MEASURES OF RETURN

 ISSUES IN MEASURES OF RETURN

 complicated by addition or withdrawal of money
by the investor
 percentage change is not reliable when the base
amount may be changing
 timing of additions or withdrawals is important to
measurement

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PERFORMANCE MEASURES

 Bank Administrative Institute Report, 1968

 Performance based on actual returns.
 Performance based on market value
 Portfolio manager’s performance should consider
risk also
 Cannot compare among funds operating under
different conditions

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2 RULES

 1. Arithmetic Mean is not a useful statistic

 2. Rupees are more important than
percentages.

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ARITHMETIC V. GEOMETRIC
AVERAGES
 GEOMETRIC MEAN FRAMEWORK
GM = (Π HPR)1/N - 1
where Π = the summation of the
product of
HPR= the holding period returns
n= the number of periods

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ARITHMETIC V. GEOMETRIC
AVERAGES
 ARITHMETIC MEAN FRAMEWORK
 provides a good indication of the expected rate
of return for an investment during a future
individual year
 it is biased upward if you attempt to measure
an asset’s long-run performance

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ARITHMETIC V. GEOMETRIC
AVERAGES
 GEOMETRIC MEAN FRAMEWORK
 measures past performance well
 represents exactly the constant rate of return
needed to earn in each year to match some
historical performance

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Why Rupees are more
important ?
 2 funds earned 44% and 12%
 Average rate of return 28% ?
 44% return on fund of 2,50,000
 12% return on fund of 400,00,000
 Average return is
 (0.9938*12%) + (0.0062*44%) = 12.10%

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Traditional Measures

 NAV change
 NAV change with index
 NAV yield
 Sharpe’s Performance Measure
 Treynor’s Performance Measure
 Jensen’s Measure

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NAV Based Measures

 NAV change over the investment period.

 NAV Yield (NAVt+Dt / NAVt-1 - 1)*100
 NAV change with index

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THE USE OF MARKET INDICES

 INDICES
 are used to indicate performance but depend
upon
 the securities used to calculate them
 the calculation weighting measures

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RISK-ADJUSTED MEASURES OF
PERFORMANCE
 THE REWARD TO VOLATILITY RATIO
(TREYNOR MEASURE)
 THE REWARD TO VARIABILITY (SHARPE
RATIO)
 THE JENSEN MEASURE OF PORTFOLIO
PERFORMANCE

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TREYNOR MEASURE

 THE REWARD TO VOLATILITY RATIO

There are two components of risk
 risk associated with market fluctuations
 risk associated with the stock
 Characteristic Line (ex post security line)
 defines the relationship between historical portfolio
returns and the market portfolio

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TREYNOR MEASURE
 TREYNOR MEASURE
 Formula

arp − ar f
RVOL p =
βp
where arp = the average portfolio return
arf = the average risk free rate
β p = the slope of the characteristic
line during the time period

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TREYNOR MEASURE

THE CHARACTERISTIC LINE

arp SML

β p

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THE SHARPE RATIO
 THE REWARD TO VARIABILITY (SHARPE
RATIO)
 measure of risk-adjusted performance that uses a
benchmark based on the ex-post capital market
line

total risk is measured by σ
p
 indicates the risk premium per unit of total risk
 uses the Capital Market Line in its analysis

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THE SHARPE RATIO

 SHARPE RATIO
 formula:
ar p − ar f
SR p =
σp
where SR = the Sharpe ratio
σ p= the total risk

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THE SHARPE RATIO

arp CML

σ p

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THE JENSEN MEASURE OF
PORTFOLIO PERFORMANCE
 BASED ON THE CAPM EQUATION

E (ri ) = RFR + β [ E (rm ) − RFR ]

 measures the average return on the portfolio over
and above that predicted by the CAPM
 given the portfolio’s beta and the average market
return

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THE JENSEN MEASURE OF
PORTFOLIO PERFORMANCE
 THE JENSEN MEASURE
 known as the portfolio’s alpha value
 recall the linear regression equation

y=α +β x+e
 alpha is the intercept

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 COMPARING MEASURES OF
PERFORMANCE
 TREYNOR V. SHARPE
 SR measures uses σ as a measure of risk while Treynor uses β
 SR evaluates the manager on the basis of both rate of return

performance as well as diversification

 Sharpe measures is for portfolios only where as Treynor’s measure

can be used for portfolios as well as single securities.

 for a completely diversified portfolio

 SR and Treynor give identical rankings because total risk is really

systematic variance
 any difference in ranking comes directly from a difference in

diversification

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MEASURES OF RETURN
 In case of cash with drawls and cash deposits :
 Dollar-Weighted Returns

 uses discounted cash flow approach

 weighted because the period with the

greater number of withdrawals or deposits or

transaction of shares has a greater influence
on the overall average
 Also known as IRR

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 CALCULATION

Value days return Annualized return Rupee

Weighted
average return

Annualized return = return * 365 / days

Dollar Weighted average return = value * Annualized return / total value

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