dr. lokanandha reddy irala() 1 portfolio performance evaluation return based methods

Dr. Lokanandha Reddy Irala(www.irala.org) 1

Portfolio Performance Evaluation

RETURN BASED METHODS


Measures of return

Time-Weighted Rate of Return(TWROR)

Money-Weighted Rate of Return(MWROR)

Linked Internal Rate of Return(LIROR)


Time-Weighted Rate of Return(MWROR)

Compute the return on the portfolio for each sub period

Average the individual sub period returns


Money-Weighted Rate of Return(MWROR)

IRR over the period Factors affecting MWROR

The beginning and ending market values Size and timing of intermediate cash

flows


1. Return based Methods

1.1 Change in NAV Method

100

NAV Begining

NAV BeginingNAV EndingNAVin Change %

1.2 Total Returns Method

100

NAVBegining

dDistribute Dividends) NAVBegining - NAV(Ending Return Total

1.2 Total Returns Method Doesn’t Consider TVM



1.3. Rupee weighed Returns Example I: A case of dividends Suppose the beginning NAV is Rs. 100. You

have received Rs. 5 as the dividend at the end of 6 months and at the end of the year the NAV is Rs. 110

EoY 0 0.5 1

CF -100 5 110



1.3. Rupee weighed Returns Example II: A case of fresh Investment Suppose the beginning NAV is Rs. 100. You

have invested another Rs. 10 at the end of 6 months and at the end of the year the NAV is Rs. 120.

EoY 0 0.5 1

CF -100 - 10 120


Risk adjusted Methods

Differential Return : Jensen’s Alpha

Return per unit Risk Sharpe’s RVAR Treynor’s RVOL


Sharpe’s measure

Sharpe’s measure Excess Return per Unit Total RISK

p

fpa RRmeasuresSharpe

'

Larger the ratio, better is the performance of the fund


Treynor’s measure

Treynor’s measure Excess Return per Unit SYS. RISK

p

fp RRmeasuresTrenyor

'

Larger the ratio, better is the performance of the fund


Jensen’s Alpha

Given a good estimate of the risk free rate, use the SML to arrive at the expected return on the portfolio

pfmfp rrrrE )()(

pr is the actual return on the portfolio

ppp rEr The fund is said to have performed better if Jensen’s Alpha is + Ve else other wise.


Appraisal ratio

Divide the Alpha of the portfolio by the non systematic risk of the portfolio


M2 Measure

Compare the return on Managed portfolio with that of the market after adjusting the managed portfolio to carry the same SD as market

Consider the following

Portfolio P Market M

Avg. Return 35% 28%

Beta 1.20 1.00

Standard Deviation 42% 30%

Non systematic Risk σ(e)

18% 0


M2 Measure Adjusted Managed Portfolio

Is created by mixing the managed Portfolio with a risk free asset

Thus the Variance of Adjusted Portfolio shall be


M2 Measure Setting the SD of Adjusted Managed

Portfolio equal to Market


M2 Measure Adjusted Managed portfolio

Invest .714(30/42) in P and rest in rf

Return on Adjusted Portfolio (.714x35%) +(.286x6%)=26.7%

M2= adj rp-rM

M2 =26.7%-28%=-1.3%


Performance Attribution Asset Allocation Stock Selection


Performance Attribution

rearranging

Total Contributio

nAsset

AllocationStock

Selection


Morning Star Ratings A ranking ranging from one to five stars, with

one being the poorest rank and five being the best

given to publicly traded mutual funds and ETFs by the investment research firm Morningstar.

Morningstar's risk ratings, also called star ratings, are designed to help investors quickly identify funds to consider purchasing for their portfolios.

These ratings are intended to be a starting point for further research and are not buy or sell recommendations.


Morning Star Ratings Morningstar risk ratings have been around

since 1985 and are based on the fund's past performance, the fund manager's skill, risk- and cost-adjusted returns, and performance consistency.

Morningstar assigns a one-star rating to 10% of the funds it evaluates, a two-star rating to 22.5% of funds, a three-star rating to 35% of funds, a four-star rating to 22.5% of funds and a five-star rating to 10% of funds.

Morningstar also provides category ratings and peer-group ratings to help investors further compare funds.

dr. lokanandha reddy irala() 1 portfolio performance evaluation return based methods

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