Chapter 24 – Portfolio Performance Evaluation
24-1
CHAPTER TWENTY-FOUR
PORTFOLIO PERFORMANCE EVALUATION
CHAPTER OVERVIEW
This chapter discusses and calculates various return measures and risk-adjusted return measures that are
LEARNING OBJECTIVES
After studying this chapter, the student should be able to: calculate various risk-adjusted return measures,
PRESENTATION OF MATERIAL
24.1 The Conventional Theory of Performance Evaluation
Obtaining an accurate estimate of risk-adjusted performance for a portfolio manager is very difficult.
Most of the sound measures of risk adjusted returns require stability for the portfolio. Most portfolios are
actively managed and the stability assumptions are not met. Many industry measures of performance are
Evaluating performance based on average return alone is not very useful. Returns must be adjusted for
risk before they can be compared meaningfully. The simplest and most popular way to adjust returns for
portfolio risk is to compare rates of return with those of other investment funds with similar risk
characteristics. For example, high-yield bond portfolios are grouped into one “universe,” growth stock
equity funds are grouped into another universe.
The chapter presents other measures of performance. Jensen’s alpha is a measure of the percentage
abnormal return using the adjustment of the market model. The Jensen measure does not scale returns for
risk and is therefore not as complete as the Treynor measure. The information ratio measures the alpha
Chapter 24 – Portfolio Performance Evaluation
24-2
The question of which measure is most appropriate depends on additional investment assumptions. If the
investment is limited to a single managed portfolio, the Sharpe measure is the most appropriate. If non-
24.2 Performance Measurement for Hedge Funds
The chapter develops an application of the information ratio that demonstrates how to allocate funds for a
hedge fund. The nature of active management of hedge funds makes it difficult to apply the performance
measures.
24.3 Performance Measurement with Changing Portfolio Composition
24.4 Market Timing
24.5 Style Analysis
One of the significant findings on performance was done by William Sharpe. He analyzed performance
24.6 Performance Attribution Procedures
The measures used in industry are often based on performance attribution. An overview of the concept of
performance attribution is presented here. The simplest form of attribution breaks the portfolio into
common stock, long-term debt and cash equivalents. The purpose is to compare the components and
Chapter 24 – Portfolio Performance Evaluation
Excel Models
Two excel models that cover material in this chapter are available on the Online Learning Center