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Unformatted text preview: Chapter 22: Evaluation of Investment Performance CHAPTER OVERVIEW This chapter, which is concerned with measuring portfolio performance, is a logical concluding chapter for an investments text. The bottom line of investing for investors is deciding how well their portfolio performed and if they need to make changes. Chapter 22 is a typical chapter in this area, covering the composite measures of portfolio performance as well as some of the newer concepts such as performance attribution. Although the composite measures have some problems, there is nothing better that is widely accepted, these measures are often seen and used in both textbooks and in the popular press, and they are easy to understand. The chapter begins with a discussion of what is involved in evaluating portfolio performance, including the need to adjust for differential risk and differential time periods, the need for a benchmark, and constraints on portfolio managers. It also considers the difference between the portfolio's performance and the manager's performance. Included in the discussion is an outline of AIMR's presentation standards, which likely will have a major impact in this area. These are minimum standards for presenting investment performance. These standards are being widely adopted by investment management firms. The dollar-weighted and time-weighted returns measures are described, and the issue of risk is considered. For expositional and other purposes at this level, the discussion centers around the three well-known risk-adjusted (composite) measures of portfolio performance: Sharpe, Treynor and Jensen. Each of these is developed and illustrated separately. Actual mutual fund data is used to show how the measures are computed and evaluated. Additional discussion involves a comparison of the measures to each other, such as how the Sharpe and Treynor measures compare. More extensive data and diagrams are used than was the case in the fourth edition. Along with the discussion of the measures themselves is related discussion of such issues as how to measure diversification. Also, capital market issues related to Jensen's measure are considered. 22-1 The chapter next considers the problems with portfolio measurement. This remains an unsettled issue in investments, with people using different measures and techniques, different benchmarks, and so forth. Students should be made aware that there is no standardized, widely accepted approach to this problem. The chapter concludes with other issues in performance evaluation. Performance attribution is briefly considered. CHAPTER OBJECTIVES 1. To outline the issues involved in measuring portfolio performance, including the problems that remain....
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