Performance Measures Flashcards
What proportion of wealth is invested in active funds?
A large proportion of wealth is invested in funds that pursue active investment strategies.
How do fees compare between active and passive funds?
Active funds have considerably higher fees than passive funds.
What is the expected reward for investments?
The expected return or expected abnormal return.
What happens to returns when a strategy is leveraged?
A twice-leveraged strategy has twice the return/alpha of an unleveraged version of the same strategy.
What is the Sharpe Ratio?
The most common performance measure, which evaluates the reward-to-total-risk tradeoff
What does the Sharpe Ratio measure?
It compares performance to total risk and represents the slope of the capital allocation for a portfolio.
What does a higher Sharpe Ratio indicate?
A more desirable portfolio due to a better risk-reward tradeoff.
What is the M² Measure?
A more intuitive performance measure than the Sharpe Ratio, adjusting a portfolio to match market risk before comparison.
How is the Treynor Measure calculated?
It is the average excess return divided by beta, measuring the reward to systematic risk.
Why does the Treynor Measure use beta instead of total risk?
Because systematic risk cannot be diversified away and should be penalized.
What is Jensen’s Alpha?
It measures abnormal returns by comparing actual returns to expected performance based on beta.
How is Jensen’s Alpha estimated?
As the intercept from a regression analysis
What is the Information Ratio?
t is Jensen’s Alpha divided by the standard deviation of tracking error, measuring performance relative to risk.
When should the Sharpe Ratio be used?
When selecting a portfolio to represent an entire investment.
When should the Treynor Measure be used?
When selecting a portfolio as part of a set of sub-portfolios.
When should the Information Ratio be used?
When seeking an active portfolio to mix with an index portfolio.
What did William Sharpe argue about active investment?
After accounting for costs, active investment is a negative-sum game in terms of net returns.
Why is performance evaluation important for hedge funds?
Due to their high fees, investors must ensure performance justifies costs.
What is a high-water mark in hedge funds?
The highest price a fund has achieved in the past, used to determine performance-based fees.
What is drawdown in hedge fund strategies?
The cumulative loss from a peak, representing downside risk.
Why is market timing used in active portfolio management?
It shifts funds between a market index and a safe asset to optimize returns.
How is investment performance typically measured?
By comparing fund returns with a benchmark index matching the fund’s investment style.
What are the two main types of equity funds?
Passive Funds and Active Funds.
What are the different types of bond funds?
High-yield bond funds, Money market funds, and Municipal bond funds.
Why is style analysis important for hedge funds?
Hedge fund strategies are often unclear, and style analysis helps assess investment approaches.
What are the strengths of style analysis?
It works for any strategy with existing indices, uses high-frequency return data, and detects misleading fund statements.
What are the weaknesses of style analysis?
It provides an average over time rather than a snapshot, struggles with correlated benchmarks, and is ineffective for rapid style rotators.
