Scribd
Upload
47 views14 pages

Performance Slides

This document discusses methods for evaluating investment performance, including: 1) Passive management strategies that track market indexes versus active management strategies that aim to beat the market. 2) Risk-adjusted measures like Jensen's alpha, the Information Ratio, and the Sharpe Ratio that compare returns of actively managed portfolios to benchmarks adjusted for risk. 3) The R package PerformanceAnalytics that can be used to statistically evaluate different performance measures and test if an active strategy exhibits superior performance to a passive benchmark.

Uploaded by

hatem
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
47 views14 pages

Performance Slides

This document discusses methods for evaluating investment performance, including: 1) Passive management strategies that track market indexes versus active management strategies that aim to beat the market. 2) Risk-adjusted measures like Jensen's alpha, the Information Ratio, and the Sharpe Ratio that compare returns of actively managed portfolios to benchmarks adjusted for risk. 3) The R package PerformanceAnalytics that can be used to statistically evaluate different performance measures and test if an active strategy exhibits superior performance to a passive benchmark.

Uploaded by

hatem
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 14

Portfolio Performance Measurement

Eric Zivot

December 8, 2009
1 Investment Styles

1.1 Passive Management

• Believe that markets are in equilibrium

— Assets are correctly priced

• Hold securities for relatively long periods with small infrequent changes
• Hold surrogates for market portfolio known as index funds

— Low cost diversified portfolios (e.g. Vanguard Index Funds)

— motivated by portfolio theory and CAPM: efficient portfolios are com-


binations of T-Bills and a market index portfolio

• Do not try to create portfolios to “actively” beat the returns on index


funds
1.2 Active Management
• Markets are not always in equilibrium

— Some securities are “mis-priced”

• Buy under-priced (positive “alpha”) assets and sell over-priced (negative


“alpha”) assets

• Active managers often “tweak” a benchmark (index) portfolio

weight in weight in active


Security
benchmark active port position
MSFT .05 .10 +.05
GM .02 -.05 -.07
.. .. .. ..
• Active management strategies

— individual stock selection

— sector selection (e.g. utility, technology)

— asset class selection (stocks, bonds, real estate)

• Most mutual funds are actively managed.

— management fees can vary substantially from fund to fund

— fee is often a percentage of assets under management


2 Evaluating Investment Performance

Q: Is it worthwhile to “pay” for active management of portfolios?

Key Concepts

• Actively managed portfolios should be compared with passive (index) bench-


marks of a similar risk class

• Superior past performance could be luck or could be skill

• Often very little historical data to evaluate managed portfolios

— Statistical analysis is difficult


2.1 Risk Adjusted Measures of Performance

Observe returns on active portfolio and benchmark over some time horizon (e.g.
5 years of monthly data)

• Does the managed portfolio exhibit superior performance adjusted for risk?

• How to rank different actively managed portfolios?


Measures of risk

• Market risk (portfolio beta, β p, from SI model or CAPM)

• Total risk (portfolio standard deviation, σ p)

Ex Post (Historical) measures

1 XT 1 XT
μ̂p = Rp,t, r̂f = rf,t
T t=1 T t=1
⎛ ⎞1/2
1 T
X
σ̂ p = ⎝ (Rp,t − μ̂p)2⎠
T − 1 t=1
d
cov(R p,t, RM,t)
β̂ p =
vd
ar(RM,t)
Types of Performance Measures

• Average return difference adjusted for risk

ave return on active portfolio -


ave return on risk adjusted benchmark

• Risk adjusted reward/risk ratio


average excess return
risk measure
2.1.1 Performance Measures Based on Market Risk

Idea: Under CAPM, market risk is captured by β and expected returns are
captured by the Security Market Line (SML)

μp,CAP M = rf + β p(μM − rf )
Jensen’s alpha

Risk-adjusted return difference

α̂∗p = μ̂p − μ̂p,CAP M


Computation: use linear regression to estimate the excess returns SI model

Rp,t − rf = α∗p + β p(RMt − rf ) + εpt, εpt ∼ iid N (0, σ 2ε )


Statistical evaluation:

H0 : α∗p = 0 (no superior performance) vs. H1 : α∗p 6= 0


Information Ratio
dp =
α̂∗p
IR
σ̂ ε

Statistical evaluation: Use bootstrap to compute standard error and confidence


interval
2.1.2 Performance Measures Based on Total Risk

Idea: Efficient portfolios are combination of T-bills and tangency portfolio.


Under CAPM, the tangency portfolio is the market portfolio

Sharpe ratio
μ̂p − r̂f
SRp =
σ̂ p
= excess return per unit portfolio risk

Statistical evaluation:
H0 : SRp = SRM (no superior performance) vs H1 : SRp 6= SRM

Evaluate H0 using bootstrap


R Package for Performance Evaluation

PerformanceAnalytics

You might also like