Business and Economics Technical Content Go8 Business and Economics Funds Management Performance (BKM Ch 24) Introduction § Investment Performance is a complicated subject § Theoretically correct measures are difficult to construct § Different statistics or measures are appropriate for different types of investment decisions or portfolios § Many industry and academic measures are different § The nature of active management leads to measurement problems Introduction § Two common ways to measure average portfolio return: 1. Time-weighted returns 2. Dollar-weighted returns § Returns must be adjusted for risk. AFF5300 Case Studies in Finance 4 Dollar- and Time-Weighted Returns …show more content…
AFF5300 Case Studies in Finance 17 2 standard deviation = 30% Figure 24.2 M of Portfolio P 2 AFF5300 Case Studies in Finance 18 Which Measure is Appropriate? It depends on investment assumptions 1) If the portfolio represents the entire risky investment , then use the Sharpe measure. 2) If the portfolio is one of many combined into a larger investment fund, use the Jensen α or the Treynor measure. The Treynor measure is appealing because it weighs excess returns against systematic risk. AFF5300 Case Studies in Finance 19 Portfolio Performance Is Q better than P? AFF5300 Case Studies in Finance 20 Treynor’s Measure AFF5300 Case Studies in Finance 21 Performance Statistics AFF5300 Case Studies in Finance 22 Interpretation of Table 24.3 § If P or Q represents the entire investment, Q is better because of its higher Sharpe measure and better M2. § If P and Q are competing for a role as one of a number of subportfolios, Q also dominates because its Treynor measure is higher. § If we seek an active portfolio to mix with an index portfolio, P is better due to its higher information ratio. AFF5300 Case Studies in Finance 23 Performance Measurement for Hedge Funds § When the hedge fund is optimally combined with the baseline portfolio, the improvement in the Sharpe measure will be determined by its information ratio: ⎡ α H ⎤ S = S + ⎢ ⎥ ⎣ α (eH ) ⎦ 2 P 2 M 2 AFF5300
STP) and one risky asset (i.e. US Equities) and the expected return and risk are also linearly related to the weight in the risky asset. The highest Sharpe ratio from these risk-return opportunities available is also where 90% of the portfolio is comprised of STP and 10% of US Equities.
Each strategy will be used in a different way or ‘style,’ leaving funds of the same strategy with varying results. For example Australian Equity had an average one year return of -6.76 per cent, while Australian Fixed Interest had an average one year return of 6.99 per cent. Comparing the average one year return for each strategy illustrates which funds have the most reliable or steady rate of return, and in this case the most reliable funds are those with fixed interest. This is coherent with the risk factors associated with the different strategies, even though fixed interest is considered low risk and offers low returns, these returns are more reliable than strategies with a high risk, and therefore still perform positively under times of economic crisis.
In order to find the optimal portfolio allocation, the group needs to find the portfolio structured with lowest risk under a given return. This can be achieved by applying Mean-Variance Theory and Markowitz model find the efficient frontier, which yields the most optimal portfolio under given returns. It can be expressed in mathematical terms and solved by quadratic programming. [Appendix A]
CAPM results can be compared to the best expected rate of return that investor can possibly earn in other investments with similar risks, which is the cost of capital. Under the CAPM, the market portfolio is a well-diversified, efficient portfolio representing the non-diversifiable risk in the economy. Therefore, investments have similar risk if they have the same sensitivity to market risk, as measured by their beta with the market portfolio.
Standard deviation and coefficient of variation are measures of dispersion about the mean, and hence measure total risk. Total risk is the relevant measure of risk only for assets held in isolation. Of the two total risk measures, coefficient of variation is the better one because it relates risk to the expected rate of return; that is, it standardizes the measure.
“…anointing winners and losers on the basis of 12 months’ worth of performance is silly in the context of portfolios that are being managed with incredibly long time horizons.” — David F. Swensen, Chief Investment Officer, Yale University1
Performance measures have been used to assess the success of organisations. The modern accounting framework dates back to the middle ages and since that time assessment of performance has predominantly been based on financial criteria (Burns, 1998). Double entry accounting systems were developed to avoid disputes and settle transactions between traders (Johnson, 1983). By the start of the twentieth century the nature of organisations had evolved and ownership and management were increasingly separated. As a result, measures of return on investment were applied so that owners could monitor the performance that managers were achieving (Johnson, 1983). Since that time
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4.In deciding the investment base for evaluating managers of investment centers, the general question is: What practices will motivate that district managers to use their assets most efficiently and to acquire the proper amount and kind of new assets? Presumably, when his ROA is being measured, the district manager will try to increase his ROA, and we desire that the actions he takes toward this end be actions that are in the vest interest of the whole corporation. Given this general line of reasoning, evaluate the way Quality computes the “investment base” for its districts. For each asset category, discuss whether the basis of measurement used by the company is the best for the purpose of measuring districts’ ROA. What are the likely motivational problems that could arise in such a system? What can you recommend to overcome
In 1952 the basic concept of the modern portfolio theory was written by Harry Markowitz, in which he explained that assets in an investment portfolio are not only to be selected on the basis of its merit but also by how it’s price changes relative to every other asset in the portfolio. Investment can be stated as a trade-off between expected return and risk, the riskier the investment the higher the return and vice versa. It allows us to make a decision to choose between the portfolio with either the highest rate of return or the lowest amount of risk. The risk of different stocks can be reduced if a portfolio consists of stocks with different risks and returns for example; if stock A has high risk and stock B has low risk, the overall portfolio risk is less, as it is the weighted average of both risks. Owning different shares with different risks in a portfolio is known as diversification. Markowitz hence developed the efficient frontier of portfolio, the efficient set in which investors choose the most suitable portfolio for them. This concept gave birth to the Capital asset pricing model by William Sharpe in 1964 and linter 1965; they state that there are two types of risk, systematic risk and unsystematic risk. The former is the market risk that cannot be diversified while the latter is the risk associated with individual stocks which can be reduced through diversification as stated by the MPT (Investopedia, 2003) Investors basically invest by delaying consumption now
As the world economy is growing with different new company types and services, pressure to managers are seems to be rising. Back in the days owners/stake holders used to make decision for the organization, but now a days as the industry is growing and the workload has been distributed according to employee’s skills. Different department has been established in an organization and even every department managers have to take critical decisions in a glance to justify their business future and Probability. And to make the right decision, there are various kinds of measures that can be applied to the organization to see its growth. Especially in term of investment it is really important to go for the right investment, otherwise the investing capital can waste which is neither good for the Organization nor the managers taking decision upon. So critically evaluate the business facts is a must for both the managers’ career and the company future. So using the measures on right time and right place to make critical decision on short and long term, it is really important to know
“Traditional Investment Appraisal techniques cannot cope with the fast changing environment in manufacturing industry today”
Fund performance is measured through several benchmarks models that include the domestic four-factor model, Capital Asset Pricing Model, Jensen’s Alpha model and the Fama-French 3 factor model. These models of calculating the performance of mutual funds considers both domestic and foreign because Hong Kong is host to several foreign mutual fund companies that influence
Finance is a field that studies and addresses the ways in which individuals, businesses, and organizations raise, allocate, and use monetary resources over time, taking into account the risks entailed in their projects. The term finance may thus incorporate any of the following:
In this process, Indian mutual funds have emerged as strong financial intermediaries and are playing a very important role in bringing stability to the financial system and efficiency to resource allocation Mutual funds have opened new vistas to investors and imparted much-needed liquidity to the system.