performance%20evaluation%20DQ

performance%20evaluation%20DQ - Session 10: Comparing the...

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Unformatted text preview: Session 10: Comparing the Performance of Funds A. Sharpe Index Treynor Index Jensen Alpha Appraisal Ratio Yankee 0.2272 0.0045 0.0012 0.1740 Dow Jones 0.1487 0.0016 B. The Sharpe index measures the slope of a capital allocation line which summarises the risks and expected returns of balanced portfolios formed by combining the risk free asset and a portfolio of risky assets in different proportions. In hindsight, these balanced portfolios are formed at the beginning of, rather than during, the evaluation period. C. One may apply the Sharpe index, Treynor index, Jensen alpha, appraisal ratio or any other measures to rank portfolios. A portfolio is said to have beaten another one if this portfolio has a larger performance measure. Alternatively, this portfolio has earned a larger excess return per unit of risk. D. Among all the portfolio of risky assets lying on the efficient frontier, the capital asset pricing model asserts that the market portfolio offers the largest excess return per unit of risk (see the CML) and should be chosen by all investors. An investor who can tolerate more (less) risk than that of the market portfolio may borrow (lend) risk-free to achieve other efficient risk-return combinations. Thus the market portfolio is the benchmark against which all portfolios of risky assets should be compared. Since the excess return per unit of risk is in fact the Sharpe ratio and the above performance evaluation has not compared the Sharpe ratios of the managed portfolio with that of the market index portfolio, the finding is insufficient to convince me to invest in the fund. E. The result suggests that the fund manager has demonstrated his/her skills to consistently include under-valued stocks in the portfolio, i.e., stocks were purchased at their lows before the market realises the mispricing. However, you should be aware of the following before committing your money to this fund: • superior past performance does not necessary imply superior future performance • ensure that the manager has not been head-hunted by other institutions • you must be satisfied with the level of unsystematic risk, as reflected by the fund’s residual variance, as a result of the weighting bias towards the underpriced stocks. F. When a fund manager shifts funds towards a group of securities that are believed to be underpriced, the fund manager has effectively sacrificed diversification and raised the level of unsystematic risk of the portfolio for the sake of demonstrating his/her ability to pick underpriced securities. Therefore, the appraisal ratio, which is defined as alpha divided by the portfolio residual variance, may be used to rank the two portfolios. A larger appraisal ratio is preferred because this reflects the ability of the fund manager to select and invest in a larger number of underpriced securities so as to keep the unsystematic risk down. 1 ...
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