PerformanceEvaluation

# PerformanceEvaluation - Performance Evaluation The market...

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1 Performance Evaluation The market model and multi-factor models allow us to analyze average returns, risk, and investment strategies Average returns: How much is alpha and how much is beta? Risk: How much is systematic and how much is idiosyncratic? Strategies: Are we using value/growth or small/big, etc.? Today, we ll apply these ideas to professional investors How do they perform? Do they beat their benchmark(s)? How risky are their portfolios? What risks do they take? Who measures fund performance? Funds rating services: e.g. Morningstar, Lipper. Institutional Fund Consultants

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2 Equity Styles Abnormal returns = Average fund return – Average Benchmark returns Q: Can we use the S&P 500 as the benchmark for all funds?
3 Sharpe Ratio P f p p r r S σ = S P > S mkt indicates superior performance. S P < S mkt indicates inferior performance . Q . When would you use the Sharpe ratio to rank funds?

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4 M 2 measure Develop by Modigliani and Modigliani Equates the volatility of the managed portfolio with that of the market by creating a hypothetical portfolio made up of T-bills and the managed portfolio Q: A fund return was 10% with a standard deviation of 20%. The market return over the same period was 7% with a standard deviation of 18%. The risk free rate was 3%. What was the fund Sharpe Ratio and M 2 ? 2 * P M M r r =
5 Jensen s alpha ( ) Expected Return under CAPM p m p f p f r r r r α β = + 1 4 44 2 4 4 43 are average past returns of the fund and the market Q. Is looking at alphas sufficient to compare two actively managed portfolios directly? m p r and r

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6 Portfolio X has an α =2% and a beta=0.8, portfolio Y has an α =4% and a beta=2. Should you invest in Y or X? Treynor Ratio: p f p p r r T β =
7 Information Ratio Measures the reward for each unit of risk, where risk is non-systematic risk. Often used to measure the performance of Hedge Funds p e p σ α = IR

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8 Info Ratio and Sharpe Ratio If you hold a benchmark portfolio, an optimal weight on a new fund increases your Sharpe ratio from SR bench to SR new : Example: Suppose you hold the S&P 500, but you re considering adding Vanguard s active Windsor fund (VWNDX). How much can you improve your Sharpe Ratio?
• Fall '14
• FranciscoBarillas
• Valuation, Alpha

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