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Brailsford3eSM_Ch20 - Chapter 20 Performance evaluation of...

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Copyright © 2006 Nelson Australia Pty Limited Chapter 20 Performance evaluation of managed funds Learning objectives After the completion of this chapter, you should be able to: calculate a range of performance measures for investment portfolios discuss and analyse various performance measurement models and benchmarks appreciate the relevance of past performance information for decision-making understand how to assess the performance of managed funds discuss the evidence concerning the performance of managed funds Key points 1 This chapter focuses on traditional measures of performance; Sharpe, Treynor and Jensen measures, as well as some more advanced measures like market timing and index tracking. 2 The evidence suggests little evidence of superior fund performance, but some evidence of persistence, particular for poorly performing funds. Chapter outline 20.1 Introduction 1 The key unanswered questions with respect to the funds management industry are: Is past performance relevant? How can fund management be measured? and What has been the evidence on fund manager’s performance? 20.2 The relevance of past performance 1 Is past performance relevant for future investment decisions? Ad hoc evidence suggests this is true. 2 Empirical research finds past performance is correlated with future fund flows. That is funds with good past performance generate greater investor interest. 20.3 Performance measures 1 Funds management industry places important emphasis on performance measures and are published in many media. 2 Examples include tracking error and absolute tracking error, Jensen’s alpha, Sharpe ratio and the Treynor measure. More recent measures include the information ratio and measures of market timing.
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2 Investments: Concepts and Applications Solutions Manual Copyright © 2006 Nelson Australia Pty Limited 20.4 Performance studies 1 Early studies found that managed funds, on average, under-performed the benchmarks. 2 More recent evidence finds some persistence, with the stronger evidence being towards poorly performing funds, which tend to perform poorly in future periods. Solutions to text problems Problems and applications 1 Stock selection involves the selection of securities within an asset class. An active management style involves selecting stocks which are believed to be ‘mispriced’. Therefore, active stock selection must involve an analysis of market prices. As such, valuation analysis is used in active stock selection. The effectiveness of active stock selection depends on the fund manager’s valuation skills and the market’s lack of skills. If the manager can value securities more accurately than the market, then there is a strong chance that active stock selection will work. However, the empirical evidence generally shows that fund managers,
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