Ch 16 - Performance Measurement (2) Flashcards
Portfolio Risk and Return Analysis
This typically involves plotting the overall time-weighted return from a portfolio over a period against the “riskiness” of the portfolio.
It is used to assess whether superior investment performance has been obtained by taking more risk or by superior market and stock selection/timing
The portfolio is compared to its peer group and to simulated portfolios such as median trackers
In practice, control over risk can be achieved by:
Guidelines on asset allocation and stock weightings
And by specifying a maximum under-performance over specified periods
Downside measures of risk may be of use here
Some problems with relying on the frequent risk and return analysis approach are:
Creeping change in portfolio composition (and overall volatility)
A successful investment manager may be treated unfairly by the measurement system
The manager may simply disagree with the market view of a stock’s or market’s prospects and/or uncertainty attached to those prospects
Market Price:
Changes in the market price of an equity would usually be regarded as a measure of the success or failure of that investment decision. However:
Dividend income must be allowed for
Equity price may be influenced by short-term concerns whereas many investors are more focussed on the long term
Net Present Value:
The NPV of an investment may be of limited use for performance measurement as it depends on many assumptions which can produce a wide variety of results
In particular, an investor’s estimate of NPV may differ from the market price due to:
Difference between the particular investor and the average investor
Other differences in assumptions
Note:
The trend of NPV estimates and their relationship to market prices may be helpful
Net Asset Value
The NAV of a company, or the NAV per share, is clearly only one component of overall value
All things equal, a share with higher proportion of its share price represented by NAV should be cheaper than a share that has less asset backing.
However, this difference is likely to be eliminated in an efficient market where the market value is driven by supply and demand dynamics.
In practice all things are not equal, and share price in an efficient market will reflect factors other than NAV.
Goodwill must be evaluated for relevance, and removed if inappropriate, to make a valid comparison with the company which has grown organically.
NAV is a readily available accounting number, which may require adjustments (e.g. to allow for e.g. non-quoted assets).
NAV may not allow for the extent that some businesses may be more capital intensive than others.
Intangibles e.g. human capital, may be difficult to value and unlikely to be included in NAV.
NAV does not reflect risk.
NAV may not be appropriate to compare companies in different industries / sectors.
NAV does not currently account for environmental and other less quantifiable socially responsible impacts.
The CAPM suggests that if capital assets are priced correctly then:
Returns in excess of the risk-free rate will only be generated from taking risks
The risk-adjusted return on capital should be equal to the risk-free rate
The risk-adjusted return formula is:
Actual return, reduced by Beta * (R(m) - r)
Generally a high actual projected return on capital would imply
The successful creation of intangible assets and shareholder value
When calculating capital include and value:
Goodwill from mergers/takeovers
Internally generated goodwill
Any other intangible assets
All tangible assets
When calculating return(profits/capital):
Add back to profits any investment in the creation of new intangible assets and in the expansion and purchase of tangible assets
Continue to deduct any expenses incurred defending and serving existing tangible and intangible assets
