Lecture 9.pptx - Lecture 9 Performance evaluation Topics...

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Lecture 9 – Performance evaluation
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Topics The roles of portfolio managers Evaluation of portfolio managers Market timing 2
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Roles of portfolio managers Administrative work and documentation of actions takes. Lower transaction costs (but also entails fees) Professional management of the portfolio: The proper diversification Tailoring portfolios to individuals according to age, wealth and risk tolerance Active portfolio management 3
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Active portfolio management Active portfolio management can be done in several ways: Stock picking Asset class investing (e.g. style investing, REITs etc) Market timing (rebalancing, aggressive rebalancing (even a 0-1 strategy)). 4
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Performance measures Sharpe ratio Jensen’s alpha Treynor measure 5
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Sharpe ratio If investors are risk neutral, what is the criteria by which they will evaluate managers? However, investors are likely risk averse. The Sharpe ratio of portfolio P is defined as: 6 P f P r r E ) (
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Rf B σ A Sharpe ratio Which fund is better, A or B? S 1 S 2 µ 7 B A S S 1 2
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Sharpe ratio Who should use the Sharpe ratio? Recall that investors would like to maximize the Sharpe ratio of their overall portfolio . If an investor invests all of her/his wealth in the fund, then the investor will be interested that the fund will have the highest possible Sharpe ratio. 8
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Sharpe ratio If a manager attains a higher Sharpe ratio than the market portfolio, then this manager is considered successful. Problem: we only have data on historical returns. There is not necessarily persistence in performance. 9
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Sharpe ratio Measuring the Sharpe ratio of a fund: We can evaluate past performance. Much more difficult to predict future performance. If we are willing to assume that past return moments are good proxies for expected future moments we are fine. 10 P f P r r
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The M 2 measure Was developed by Modigliani and Modigliani Suppose for example that S P = 0.40 and S m = 0.33. Obviously portfolio P was a better investment than the market. But how significant is the difference between the two? 11
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The M 2 measure In order to answer this question let us consider an imaginary portfolio P * which is a combination of portfolio P and the risk free asset.
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