Portfolio Perfomance Measures

Invitational Honorary Introductory Lecture
“ Learning for Life”

SYDENHAM INSTITUTE OF MANAGEMENT
STUDIES AND RESEARCH &
ENTREPRENEURSHIP EDUCATION
Security Analysis & Portfolio Management
Session on Portfolio Performance Measurements
To Students of MMS 2nd Year and PGDM by
GAURAV A PARIKH
CMD, Scriptech Consultancy (I) Pvt Ltd
March-April 2007
SIMSREE….SA PM…Portfolio Performance Measurements
EE….SAPM…P
Objective
To illustrate the usefulness of
knowing an investment's Risk-
Adjusted Return, Diversification
Impact and Absolute Alpha.
July 12, 2024

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SHARPE RATIO
Definition
 Risk-Adjusted Return: The return on

an asset or a portfolio, adjusted for
volatility; commonly represented by
the Sharpe Ratio.
 Sharpe Ratio: A ratio of return to
volatility; useful in comparing assets
or portfolios in terms of risk-
adjusted return.
July 12, 2024

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How does the SHARPE RATIO Work ?
The historical average return of an asset or portfolio can be
extremely misleading, and should not be considered alone
when selecting assets or comparing the performance of
portfolios. The Sharpe Ratio is such an important tool because
it allows you to factor in the potential impact of Return
Volatility on Expected Return, and to objectively compare
assets or portfolios that may vary widely in terms of returns.
July 12, 2024

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When selecting assets for inclusion in a portfolio,
or when comparing the performance of two
portfolios, it is important to look beyond average
historical return. Risk-adjusted return, as
measured by the Sharpe Ratio, provides a useful,
reliable means of factoring Return Volatility into
your assessment.
July 12, 2024

EE….SAPM…P
SHARPE RATIO
 A ratio of return to volatility; useful in comparing two
portfolios in terms of risk-adjusted return. This ratio
was developed by Nobel Laureate William Sharpe.
 The higher the Sharpe Ratio, the better - a high
Sharpe ratio implies the portfolio or stock is achieving
good returns for each unit of risk. Because we earn
returns by accepting risk, it is great when we get more
return for less risk.
July 12, 2024

EE….SAPM…P
SHARPE RATIO
 The Sharpe Ratio or the Risk-Adjusted
Return score allows us to compare
different assets or different portfolios.
 It is calculated by first subtracting the risk
free rate from the return of the portfolio,
and then dividing by the standard deviation
of the portfolio.
July 12, 2024

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SHARPE RATIO
July 12, 2024

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SHARPE RATIO : An illustration
A & B offer higher returns but risk adjusted shows C
as a better choice with risk free rate at 5%
Asset Av Annual Return Sharpe

Return Volatility Ratio
A 54.52% 177.2% .279
B 36.91% 68.2% .468
C 25.64% 22.69% .910
July 12, 2024

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SHARPE RATIO : An Indian Illustration

Tax-Saving NAV (Rs) 1-Yr 3-Yr 5-Yr (%) SD (%) SR (%)
Funds 17/1/07 (%) (%)
Top performing tax-saving funds
Magnum Taxgain 58.38 49.13 65.84 60.29 6.51 0.68
HDFC Tax Saver 151.28 39.06 53.00 53.48 6.80 0.51
Sundaram BNP 29.24 35.14 48.44 48.11 7.12 0.43
Paribas Tax Saver
PruICICI Tax 96.15 28.39 46.89 50.84 8.68 0.37
Principal Tax 78.91 46.06 42.97 48.69 7.08 0.44
Savings
HDFC Long Term 95.37 27.13 42.79 56.10 5.36 0.50
Advantage
Birla Equity 59.67 37.54 38.21 52.18 6.75 0.44
Franklin India 129.99 30.28 35.47 41.11 6.15 0.42
TaxShield
Tata Tax Saving 44.75 25.56 33.79 44.17 7.38 0.33
Birla Sun Life Tax 177.40 48.31 33.79 39.89 6.63 0.43
Relief 96
S&P CNX Nifty 41.44 28.33 30.20
BSE Sensex 48.96 33.79 33.24
July 12, 2024

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Are You Getting the Greatest Return for Your Level of Risk
Portfolio Optimization shows you how to allocate and rebalance assets to achieve optimal portfolio performance, based upon your target
risk/return profile.
GROWTH IS IMPERATIVE TO SURVIVE
July 12, 2024

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Pace of Growth through Internal Accruals
July 12, 2024

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When Sharpe is not so Sharp
 "past performance is no guarantee of future results."

When you use the Sharpe Ratio to choose between
strategies, you are only looking at past performance. It
might be a more complete picture than just looking at
past returns, but you are still using history to "predict"
thefuture.
 Second, the Sharpe Ratio can change dramatically

depending on the time period used. The Sharpe Ratio is
normally calculated by taking the average annual returns
of an investment strategy and comparing them to a "risk-
Fast TrackIf Growth
free" investment. you havethrough PEyear
a five-plus / IPO
timeframe
for your investments, the "annual return" Sharpe Ratio
isn't right for you. In effect it will overstate the volatility.
July 12, 2024

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When Sharpe is not so Sharp
 The "risk-free" rate of return: The Sharpe Ratio

calculation assumes that you can always invest and
borrow at the "risk-free" rate. This is fine if you want to
blend your risky strategy with T-bills. But, what if you
want to leverage a strategy (invest using borrowed
funds)? How many of us can borrow at the risk-free rate?
If you are thinking of leveraging a strategy, you need to
apply the interest rate at which you can borrow. This can
change your Sharpe Ratio considerably. If you can make
15% per year on your stock investments, borrowing at an
12% rate is good, but borrowing at 18% will wreck your
account.
B) Rebalancing,
Fast Trackreserves, and volatility:
Growth through PE / IPOThe Sharpe
Ratio assumes that you can maintain a constant amount
of leverage (or a constant percentage invested in "risk-
free" items). Real life is not so easy.
July 12, 2024

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Treynor Index
A measure of a portfolio's excess return per unit of risk, equal

to the portfolio's rate of return minus the risk-free rate of
return, divided by the portfolio's beta. This is a similar ratio to
the Sharpe ratio, except that the portfolio's beta is considered
the measure of risk as opposed to the variance of portfolio
returns. This is useful for assessing the excess return from each
unit of systematic risk, enabling investors to evaluate how
structuring the portfolio to different levels of systematic risk will
affect returns.
Need to be Flexible & Fighting Fit
July 12, 2024

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The Treynor ratio is a measurement of the returns

earned in excess of that which could have been earned on
a riskless investment (i.e. Treasury Bill) (per each unit of
market risk assumed).
The Treynor ratio (sometimes called reward-to-volatility ratio)

relates excess return over the risk-free rate to the additional risk
taken; however systematic risk instead of total risk is used. The
higher the Treynor ratio, the better the performance under
analysis.
Industry Heavyweight and can take on any
Competition
July 12, 2024

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portfolio return risk free rate
portfolio beta
July 12, 2024

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Like the Sharpe ratio, the Treynor ratio does

not quantify the value added, if any, of active portfolio
management. It is a ranking criterion only. A ranking of
portfolios based on the Treynor Ratio is only useful if the
portfolios under consideration are sub-portfolios of a broader,
fully diversified portfolio. If this is not the case, portfolios with
identical systematic
where
risk, but different total risk, will be rated
the same. But the portfolio with a higher total risk is less
diversified and therefore has a higher unsystematic risk which is
not priced in the market.
An alternative method of ranking portfolio management is

Jensen's alpha, which quantifies the added return as the excess
return above the security market line in the
capital asset pricing model.
July 12, 2024

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Jensen's alpha
In finance, Jensen's alpha (or Jensen's

Performance Index) is used to determine the
excess return of a stock, other security, or
portfolio over the security's required rate of return
as determined by the Capital Asset Pricing Model.
This model is used to adjust for the level of beta
risk, so that riskier securities are expected to have
higher returns. The measure was first used in the
evaluation of mutual fund managers by Michael
Jensen in the 1970's.
July 12, 2024

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To calculate alpha, the following inputs are needed:
the realized return (on the portfolio),
the market return,
the risk-free rate of return, and
the beta of the portfolio.
Jensen's alpha = Portfolio Return - (Risk free return + (Market

Return - Risk free Return) * Beta)
Need a Catalyst or else Will be a Small Player In a
Large
Alpha is still widely used Industry
to evaluate mutual fund and portfolio
manager performance, often in conjunction with the Sharpe
ratio and the Treynor ratio.
July 12, 2024

EE….SAPM…P
Thank You
gaurav@scriptechindia.com
98201 62597
July 12, 2024

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Invitational Honorary Introductory Lecture

“ Learning for Life”

Security Analysis & Portfolio Management

Session on Portfolio Performance Measurements

To Students of MMS 2nd Year and PGDM by

To illustrate the usefulness of

knowing an investment's Risk-

Adjusted Return, Diversification

Impact and Absolute Alpha.

July 12, 2024

 Risk-Adjusted Return: The return on

July 12, 2024

How does the SHARPE RATIO Work ?

The historical average return of an asset or portfolio can be

extremely misleading, and should not be considered alone

when selecting assets or comparing the performance of

portfolios. The Sharpe Ratio is such an important tool because

it allows you to factor in the potential impact of Return

Volatility on Expected Return, and to objectively compare

assets or portfolios that may vary widely in terms of returns.

July 12, 2024

When selecting assets for inclusion in a portfolio,

or when comparing the performance of two

portfolios, it is important to look beyond average

historical return. Risk-adjusted return, as

measured by the Sharpe Ratio, provides a useful,

reliable means of factoring Return Volatility into

July 12, 2024

 A ratio of return to volatility; useful in comparing two

portfolios in terms of risk-adjusted return. This ratio

was developed by Nobel Laureate William Sharpe.

 The higher the Sharpe Ratio, the better - a high

Sharpe ratio implies the portfolio or stock is achieving

good returns for each unit of risk. Because we earn

returns by accepting risk, it is great when we get more

return for less risk.

July 12, 2024

 The Sharpe Ratio or the Risk-Adjusted

Return score allows us to compare

different assets or different portfolios.

 It is calculated by first subtracting the risk

free rate from the return of the portfolio,

and then dividing by the standard deviation

July 12, 2024

July 12, 2024

SHARPE RATIO : An illustration

A & B offer higher returns but risk adjusted shows C

as a better choice with risk free rate at 5%

Asset Av Annual Return Sharpe

B 36.91% 68.2% .468

C 25.64% 22.69% .910

July 12, 2024

SHARPE RATIO : An Indian Illustration

July 12, 2024

GROWTH IS IMPERATIVE TO SURVIVE

July 12, 2024

Pace of Growth through Internal Accruals

July 12, 2024

When Sharpe is not so Sharp

 "past performance is no guarantee of future results."