1. Intermediate Investments F3051 Measures of Portfolio Performance Measuring returns –If a fund manager is generating high returns, pay only for alpha –Returns should be risk adjusted –Should not pay for adding additional risk –Compare to pre-established benchmarks

2. Intermediate Investments F3052 Asset and Portfolio Returns Find the HPR for and asset or portfolio of assets Find the optimal portfolio and compare to the HPR of a portfolio that is equal or value weighted When measuring a managed portfolio, must adjust for inflows and outflows beyond the manager’s control Consider the next slide

3. Intermediate Investments F3053 An example Suppose we are computing the two month return on a managed portfolio worth $10M to start After 1 month, the portfolio has grown to $12.5M ad $5M in new contributions are added making the portfolio now worth $17.5M After 2 months, the portfolio has shrunk to $13M Compute the unitized returns –Think of the initial portfolio as 10 units @ $1M each –A fictional unit is worth $1.25M after one month –The $5M cash injection buys 4 more units –After the cash injection there are 14 units @$1.25M each –At the end of the period, each is worth $13M/14 or $.93M –Unitized return on the portfolio is –7%

4. Intermediate Investments F3054 An example

5. Intermediate Investments F3055 An example (cont) Which fund has performed better, A or B? MEASURES OF THE MEANS Arithmetic averages are best used to predict future performance Geometric averages are required to be used by Mutual Funds to show historical performance

6. Intermediate Investments F3056 Risk Adjusted Measures of Portfolio Performance Sharpe Ratio M 2 Jensen’s Alpha Treynor’s Ratio

7. Intermediate Investments F3057 An Example Using the 4 Measures

8. Intermediate Investments F3058 Which Measures to Use? For compensating fund managers –Jensen’s Alpha – how much excess return over and above the expected return based on the SML For Optimal Portfolio Choice –Sharpe ratio when the portfolio represents the entire investment fund –The Treynor ratio when the portfolio represents one sub-portfolio out of many that are added together to make a passive portfolio