Week 12 - Week 12: Portfolio performance evaluation Cameron...

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1 Week 12: Portfolio performance evaluation Cameron Truong Introduction Complicated subject Theoretically correct measures are difficult to construct Different statistics or measures are appropriate for different types of investment decisions or portfolios The nature of active management leads to measurement problems Introduction Lessons : What is the Jensen portfolio performance measure? What is the Treynor portfolio performance measure? What is the Sharpe portfolio performance measure? What is the critical difference between the Treynor and Sharpe portfolio performance measures? What is the M 2 performance measure? Performance attribution analysis, benchmarking Empirical evidence of mutual fund performance and lessons! What major requirements do clients expect from their portfolio managers? What can a portfolio manager do to attain superior performance?
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2 Investment process Investment Policy Security Analysis Portfolio Construction Portfolio Revision Performance Evaluation Portfolio managed by professionals Closed-end funds The funds are listed and traded in the exchange. There is no obligation of the issuer (funds manager) to repurchase the shares when investors would like to sell the funds Open-end funds The issuer (funds manager) is obliged to buy the funds at the price close or equal to the Net Asset Value (NAV) when investors would like to sell the funds Hedge Funds Employ aggressive investment strategies, highly levered, seek arbitrage opportunities (relative value), strategies often involve complex derivatives. Others: Pension fund, superannuation fund,… Portfolio performance evaluation – a simple approach Assume that you can invest your money in one of two mutual funds. The first mutual fund had an annual average return of 10.1% in the past, and the second had an annual average return of 10%. Which one would you choose? If we evaluate the performance based on average return only, then we will choose the first mutual fund with average return of 10.1%.
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3 Portfolio performance evaluation – a less simple approach Let’s add now two new pieces of information: 1. You need the invested money to buy an apartment in two years. 2. You have the following knowledge on average returns and annual standard deviations Average return Standard deviation Mutual fund 1 10.1% 25% Mutual fund 2 10% 3% Risk-adjusted returns How can we measure returns? How can we measure risk? Standard deviation of fund returns: Beta of the fund: Pf rr P benchmark P P Portfolio performance evaluation adjusted for the risk of the investment Four common indexes of portfolio performance evaluation are: 1. The Jensen index. 2. The Treynor index. 3. The Sharpe index 4. The M 2 index Controlling for risk, compare the return of the portfolio to the return of randomly selected portfolio ( Most findings show that the returns of mutual funds are not better than the randomly selected portfolios ) Using certain indicators based on investment theory Basically we can use total risk or systematic risk in evaluation of the performance. When market portfolio is used (such as when we apply the
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This note was uploaded on 10/08/2011 for the course FINANCE 101 taught by Professor Jannis during the Three '11 term at Monash.

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Week 12 - Week 12: Portfolio performance evaluation Cameron...

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