12. Portfolio Performance Evaluation Flashcards

1
Q

Benchmarking

A

Measuring portfolio performance against relevant benchmark/standard

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2
Q

Popular benchmarks

A

S&P 500, Russell 2000 (small cap stocks), Russell 3000 (large cap or entire stock universe), S&P 400 (mid cap)

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3
Q

Performance measures

A

Capture risk-return trade off

  • Portfolio is added to existing portfolios, one of many combined into investment fund, measure systematic risk
  • Evaluating portfolio in isolation, interested in total risk
  • If adding small number stocks to passively managed portfolio, idiosyncratic risk
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4
Q

Performance measures

Treynor

A

Looks like SR, but with beta = (Rp - Rf)/ 𝛽p, dividing by beta

  • Appealing, because it weighs excess returns against systematic risk -> non- systematic risk diversified away with other portfolios
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5
Q

Performance measures

Sharpe Ratio

A

Sharpe Ratio = (Rp - Rf) / 𝜎p gives slope of line from risk-free asset to portfolio. For M move

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6
Q

Performance measures

M^2 measure

A

Alternative for SR, combine portfolio (P*) with riskless investment such that it has same standard deviation as market and then compare returns, M^2 = rP - rM

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7
Q

Performance measures

Information Ratio

A

Information ratio = αp / 𝝈(ep)

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8
Q

Problems SR

A
  • SR assumes constant mean and variance of return distribution, which isn’t realistic
  • Even if mean and variance are constant, very long period to measure performance precisely is needed
  • Many unobservable things: liquidity risk, extreme tail risk
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9
Q

Forecast ability

A
  • Manager cannot perfectly forecast market return, but is able to forecast if market outperforms risk-free asset = market timer
  • Beta risk varies: into market before market outperforms, out market otherwise
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10
Q

Test for market timing ability

A

Regress return on market: two regressions:

  • C: two values for bets (high and low market)
    o Henriksson and Merton: create dummy variable to run two betas
  • B: in reality beta may take more than two values, quadratic relation between portfolio and market returns
    o Treynor and Mazuy: risk-return in convex: the bigger the difference between π‘Ÿπ‘€ and π‘Ÿπ‘“, the stronger the outperformance
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11
Q

Evaluating performance

A

Two key problems:

  1. Many observations needed for significant results
  2. Shifting parameters when portfolios are actively managed makes accurate performance evaluation more elusive
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12
Q

Performance attribution

A

Decomposes performance into three components:

  1. Allocation choices across broad asset classes
    a. Bogey portfolio: select benchmark index portfolio for each asset class
  2. Industry/sector choice within each market
    a. Choose weights based on market expectations
  3. Security choice within each sector
    a. Choose portfolio of securities within each class by security analysis (benchmark within asset class)
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13
Q

Performance measures

Jensen alpha

A

𝛼𝑃 = 𝑅𝑃 βˆ’ 𝑅𝐹 βˆ’ 𝛽𝑃(𝑅𝑀 βˆ’ 𝑅𝐹), subtracting beta, especially different if beta is big

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