lec9-10-PerformanceMeasures - Fin406 Spring 2010 Smeal...

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Fin406 – Spring 2010 Smeal College of Business Penn State University 2/8/2010 ©2010 JingZhi Huang 1 Lectures 9-10: Performance Measures Fin 406 - Spring 2010 Professor Jingzhi Huang Smeal College of Business Penn State University Copyright © 2010 JZH I. Motivation Evaluate Performance Trade Security Selection Asset Allocation Define Objectives and Constraints Develop Market Expectations •Return •Risk •Tax •Horizon •Economy •Markets •Risk-Return Model •Benchmark Portfolios •Risk-Return tradeoff •Fixed Income •Equity •Cash •Orders •Leverage •Margin •After-tax Returns •Risk •Risk-Adj. Ret. •Benchmarks 2 Are the fund returns worth the risk and the fees ? How to measure (or rank) the performance of money managers? Introduce three widely used (risk adjusted) performance measures (also referred to as Modern Portfolio Theory Statistics ) Performance Measures Comparisons to peer groups Rank fund performance within a given category Benchmark portfolio such as an index Risk adjusted performance measures 3 Modern Portfolio Theory Statistics such as the Sharpe, Treynor, and Jensen (or alpha) measures Morningstar (risk adjusted) Ratings Return or performance attribution A very popular procedure used in industry Aspects of A Manager’ Skills Successful across asset allocations Namely, ability to market timing Empirical evidence (Brinson et al. 1991): 92%~97% of fund returns due to asset allocation 4 Superior allocation across sectors or industries within each asset class Overweight better performing sectors, underweight poorer performers Individual security selection Pick the right stocks or bonds etc. II. The Sharpe Measure A mutual or hedge fund’s Sharpe (1966) ratio S fund is defined as Intuition: The Sharpe ratio is equal to a . σ r R S fund f fund fund 5 Intuition: The Sharpe ratio is equal to a fund’s average excess return ( over a certain period of time ) per unit of total risk The Sharpe ratio is a performance measure that adjusts a fund’s (past) return for the total risk it has taken The Treynor Measure A fund’s Treynor (1966) ratio T fund is defined as where is the fund’s beta measured . r R T fund f fund fund 6 where fund is the fund s beta measured against a benchmark index Intuition: The Treynor ratio is equal to a fund’s average excess return per unit of systematic risk The Treynor ratio is a performance measure that adjusts a fund’s (past) return for the beta risk it has taken
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Fin406 – Spring 2010 Smeal College of Business Penn State University 2/8/2010 ©2010 JingZhi Huang 2 Jensen’s Alpha The alpha (also called Jensen’s (1969) alpha) of a mutual or hedge fund is . r R r R R R f m fund f CAPM fund CAPM fund fund fund ) ( ; 7 Intuition: alpha measures excess return relative to the CAPM return (return on a simple unmanaged portfolio ) As such, alpha considered a measure of “skill” Alpha is a return adjusted for the beta risk
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This note was uploaded on 04/06/2010 for the course FIN 100 taught by Professor Staff during the Fall '08 term at Pennsylvania State University, University Park.

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lec9-10-PerformanceMeasures - Fin406 Spring 2010 Smeal...

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