11. The performance of investments

Question 1

What is the difference between:

• Performance measurement.
• Performance evaluation.

Answer 1

• What has happened.
• Why it has happened.

Question 2

What is the holding period return used for?

Answer 2

To calculate the return on an investment over the period of time it is held, expressed as a percentage of the initial investment.

Question 3

What are 3 things which the holding period return does not allow for?

Answer 3

• Tax.
• Timing of receipts.
• Cash inflows/outflows.

Question 4

What is the formula for calculating the holding period return?

Answer 4

HPR = Income + (Change in portfolio value) / Portfolio value at start

Question 5

What is the money weighted return and what is it used for?

Answer 5

A modified form of the holding period return formula and is used to calculate the return over the year, adjusting for cash flows.

Question 6

What is the formula for calculating the money weighted return?

Answer 6

MWR = Income + (Change in portfolio value) - New money introduced in year / Original value of portfolio + (New money introduced x no. of months remaining in year / 12)

If new money added, subtracted from numerator. If withdrawn, added back. Logic reversed for denominator.

Question 7

When is the money weighted return not appropriate and why?

Answer 7

When trying to evaluate and compare different portfolios. Because it is strongly influenced by the timing of cash flows which could be outside the fund manager’s control.

Question 8

What can the time weighted rate of return be used for?

Answer 8

Comparing the performance of one fund manager to that of another by eliminating the distortions caused by the timing of new money.

Question 9

What is the relative return?

Answer 9

The return from an investment or portfolio measured against the return from a benchmark index.

Question 10

What is the Sharpe ratio used for?

Answer 10

To measure the % of extra return per unit of risk.

[Fund manager vs fund manger - are excessive investment returns due to skillful decisions or because of taking excessive risk… who is the sharpest?]

Question 11

What is the formula for calculating the Sharpe ratio?

Answer 11

(ROI - Risk Free Return) / SD

[Greater the number, the better]

Question 12

What is the Alpha ratio used to assess?

Answer 12

The difference between actual and expected returns given a security’s beta (CAPM).

[a fund manager’s stock picking skills]

Question 13

What is the formula for calculating the Alpha ratio?

Answer 13

Actual portfolio return - CAPM

[positive number is good]

Question 14

What is the Information ratio used for?

Answer 14

To assess risk adjusted performance of active fund managers versus a benchmark.

[Fund manager vs benchmark]

Question 15

What is the formula for calculating the Information ratio?

Answer 15

(Portfolio return - Benchmark return) / Tracking error

Question 16

What is considered a good Information ratio?

Answer 16

Anything above 0.5.

Question 17

What would a negative Information ratio signify?

Answer 17

The investor would have probably achieved a better return matching the index with an index tracker fund.

Question 18

What is performance attribution and name 4 things which may contribute to it.

Answer 18

A measure of how portfolio managers achieved their return, i.e. through:

• Asset allocation.
• Stock selection.
• Market timing.
• Risk.

Question 19

How is performance attribution achieved?

Answer 19

By comparing the composition of the portfolio with a suitable benchmark portfolio and then looking at the effects of asset allocation and stock selection separately.