Topic 8. Performance Evaluation

Question 0

Describe when the following performance measures are appropriate

1. Sharpe
2. Treynor
3. Information ratio

Answer 0

1. Sharpe: when the portfolio represents the entire diversified investment fund
2. Treynor: can apply when the portfolio represents only a sub portfolio of a larger diversified portfolio
3. Information ratio: when the portfolio represents an active portfolio to be combined with other investments to produce a larger diversified portfolio.

Question 1

Sharpe vs Treynor ratio

Answer 1

1. Sharpe divides excess return by total risk (standard deviation).
   Treynor divides excess return by systematic risk (beta)
2. Sharpe is appropriate when the fund evaluated is 100pc of investor’s total investments. Treynor is appropriate when investor allocates across a number of investments. Each investment is evaluated according to individual contribution to risk and return.

Question 2

Common attribution procedures partition performAnce improvements to…

Answer 2

Asset allocation
Sector selection
Security selection

Question 3

Which form of return calculation is best used for an estimate of expected returns

Answer 3

Arithmetic average (rather than geometric).
For future returns, use arithmetic

Question 4

Market timing

• define
• describe charts

Answer 4

Define market timing: in pure form, involved shifting funds between market index portfolio and risk free rate.

Chart:

1. If weight of market is constant, portfolio beta will also be constant and the SCL will be a straight line measured on (rp-rf) vs (rm-rf) space
2. If bull and bear markets can be predicted, investor shifts more into the market when market is expected to perform. Chart will be ever increasing slope
3. Line could also be kinked, representing beta taking on only 2 values, a large one if market expected to do well and a small one if not so well.

Question 5

When measuring performance, why is the time weighted return superior to the dollar weighted rate of return

Answer 5

The time weighted rate of return is superior because it is unaffected by the timing of portfolio contributions and withdrawals.

Question 6

Gallagher article; passive investing

Answer 6

Index managers believe that index mimicking portfolios outperform the average active fund
Active managers believe that returns in excess of the underlying benchmark index are achievable through the use of security specific and macroeconomic information.

Question 7

Active management, negatives

Answer 7

Active managers involve substantially higher expenses, because of the cost of obtaining and analyzing price sensitive information. Transaction costs are higher as active funds have higher turnover than index funds.