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Performance measurement (1) (Risk-adjusted performance measures (Treynor…
Performance measurement (1)
Money-weighted rate of return (MWRR)
represents actual rate of return earned by fund and so ca be compared with actuarial assumptions
depends on timing and amounts of net cashflows into fund. These may be outside of manager's control, so unfair to compare performance based on MWRR
Time-weighted rate of return (TWRR)
Independent of timing and amounts of net cashflows into fund
requires knowledge of fund value at date of each cashflow
doesn't give actual return
Linked internal rate of return (LIRR)
gives close approximation to TWRR if:
short inter-valuation periods are used, or
valuations occur close to dates of cashflows, or
cashflows are small relative to size of the fund, or
rate of return is very stable over each inter-valuation period.
compare performance of portfolio with index
actual value at end vs value that would have been achieved if initial value and subsequent NNM has been invested in same way as index
Compare TWRR (or LIRR) from each
compare performance of portfolio against notional fund
carefully allow for income, NNM, rebalancing, tax and expenses
Risk-adjusted performance measures
Treynor
T= (Rp-r)/βp
Sharpe
S= (Rp - r)/σp
Jensen
J= Rp - [r + βp (Rm-r) ]
pre-specified standard deviation
P= Rp - [r + (Rm-r) σp/σm]
Measures involving σ are based on capital market line, which applies only to efficient portfolios. So only use when considering entire portfolio
Measures involving β are based on security market line and so can be used in any circumstances
J and P are appropriate if required level of risk is pre-specified. Cannot be used to compare two managers taking different levels of risk (unlike T and S).
Why measure performance
improve future performance
data collected can be used for planning future strategy
measuring performance will incentivise fund managers
measuring performance will identify strengths and weaknesses
compare rate achieved against target rate
compare fund's performance against
other portfolios
index and/or
benchmark portfolio
to appraise and remunerate investment managers
disadvantages of performance measurement
past performance may be poor guide to future. Hard to distinguish good luck from skill
difficult to allow for risk
frequency- balance between spotting problems and avoiding spurious conclusions
funds with different objectives so comparisons can't be made
impact on fund manager behaviour
cost of measurement
assessing performance relative to published indices
advantage
easy to do. Data readily available and accurate
disadvantages
published indices may not be appropriate
can't attribute performance to stock and sector selection
why compare against benchmark
benchmark
can be constructed to reflect objectives of fund
can be constructed in such a way that data necessary for comparisons easily obtained
that reflects liabilities of fund avoids giving fund manager conflicting objectives
can attribute performance to stock and sector selection