Portfolio evaluation

Portfolio evaluation

• 1.
  Portfolio Evaluation
• 2.
  The Concept    Portfolio managerevaluates his portfolio performance and identifies the sources of strength and weakness. The evaluation of the portfolio provides a feed back about the performance to evolve better management strategy. Evaluation of portfolio performance is considered to be the last stage of investment process.
• 3.
  Sharpe’s Performance Index   Sharpeindex measures the risk premium of the portfolio relative to the total amount of risk in the portfolio. Risk premium is the difference between the portfolio’s average rate of return and the risk less rate of return.
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  Formula for Sharpe’s PerformanceIndex St = Rp – Rf σp
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      Rp – Portfolio’saverage rate of return Rf – Riskless rate of return σp - Standard deviation of the portfolio return The larger the St, better the fund has performed
• 6.
  Treynor’s Performance Index     Therelationship between a given market return and the fund’s return is given by the characteristic line. The fund’s performance is measured in relation to the market performance. The ideal fund’s return rises at a faster rate than the general market performance when the market is moving upwards. Its rate of return declines slowly than the market return, in the decline.
• 7.
  Treynor’s Index Formula Rp= α + βRm + ep  Rp = Portfolio return  Rm = The market return or index return  ep = The error term or the residual  α, β = Co-efficients to be estimated
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  Beta co-efficient istreated as a measure of undiversifiable or systematic risk.
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  Portfolio average return– Riskless rate of interest Tn = Beta co-efficient of portfolio
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  Tn = Rp –Rf βp
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    The larger theTn, better the fund has performed Larger Tn is more desirable because it earned more risk premium per unit of systematic risk .
• 12.
  Jensen’s Performance Index    Theabsolute risk adjusted return measure was developed by Michael Jensen. It is mentioned as a measure of absolute performance because a definite standard is set and against that the performance is measured. The standard is based on the manager’s predictive ability.
• 13.
  Jensen Model   The basicmodel of Jensen is: Rp = α +   β (Rm – Rf) Rp = average return of portfolio Rf = riskless rate of interest α = the intercept  β = a measure of systematic risk   Rm = average market return
• 14.
   αp represents theforecasting ability of the manager. Then the equation becomes Rp – Rf = αp + β(Rm – Rf) or Rp = αp + Rf + β(Rm – Rf)