Docstoc

Investment Analysis - PowerPoint

Document Sample
Investment Analysis - PowerPoint Powered By Docstoc
					Lecture Presentation Software
              to accompany

  Investment Analysis and
    Portfolio Management
              Eighth Edition
                    by
    Frank K. Reilly & Keith C. Brown

 Chapter 25
  Chapter 25 - Evaluation of
   Portfolio Performance
Questions to be answered:
• What major requirements do clients expect from
  their portfolio managers?
• What can a portfolio manager do to attain
  superior performance?
• What is the peer group comparison method of
  evaluating an investor’s performance?
     Chapter 25 - Evaluation of
      Portfolio Performance
• What is the Treynor portfolio performance
  measure?
• What is the Sharpe portfolio performance measure
  and how can it be adapted to include multifactor
  models of risk and expected return?
• What is information ratio and how it related to
  the other performance measures?
     Chapter 25 - Evaluation of
      Portfolio Performance
• When evaluating a sample of portfolios, how do
  you determine how well diversified they are?
    Chapter 25 - Evaluation of
     Portfolio Performance
• What is the Fama portfolio performance measure
  and what information does it provide beyond
  other measures?
• What is attribution analysis and how can it be
  used to distinguish between a portfolio
  manager’s market timing and security selection
  skills?
     Chapter 25 - Evaluation of
      Portfolio Performance
• What is the benchmark error problem, and what
  are the two factors that are affected when
  computing portfolio performance measures?
• What are customized benchmarks and What are
  the important characteristics that any benchmark
  should possess?
     Chapter 26 - Evaluation of
      Portfolio Performance
• How do bond portfolio performance measures
  differ from equity portfolio performance
  measures?
    Chapter 25 - Evaluation of
     Portfolio Performance
• What are the time-weighted and dollar-weighted
  returns and which should be reported under
  CFA’s Performance Presentation Standards?
• How can investment performance be measured
  by analyzing the security holdings of a portfolio?
          What is Required of
         a Portfolio Manager?
1.The ability to derive above-average returns for a
   given risk class
 Superior risk-adjusted returns can be derived from
   either
    – superior timing or
    – superior security selection
2. The ability to diversify the portfolio completely to
   eliminate unsystematic risk relative to the
   portfolio’s benchmark
    Early Performance Measures
            Techniques
• Portfolio evaluation before 1960
  – rate of return within risk classes
• Peer group comparisons
  – no explicit adjustment for risk
  – difficult to form comparable peer group
             Treynor Portfolio
           Performance Measure
• Treynor portfolio performance measure
   – market risk
   – individual security risk
   – introduced characteristic line
• Treynor recognized two components of risk
   – Risk from general market fluctuations
   – Risk from unique fluctuations in the securities in the portfolio
• His measure of risk-adjusted performance focuses on
  the portfolio’s undiversifiable risk: market or
  systematic risk
     Treynor ‘s Composite
     Performance Measure
     T
        R    i    RFR 
                  i
• The numerator is the risk premium
• The denominator is a measure of risk
• The expression is the risk premium return per unit of
  risk
• Risk averse investors prefer to maximize this value
• This assumes a completely diversified portfolio
  leaving systematic risk as the relevant risk
          Treynor ‘s Composite
          Performance Measure
• Comparing a portfolio’s T value to a similar measure for
  the market portfolio indicates whether the portfolio would
  plot above the SML
• Calculate the T value for the aggregate market as follows:



         Tm    
                 R    m    RFR       
                            m
  Demonstration of Comparative
       Treynor Measure

• Comparison to see whether actual return of
  portfolio G was above or below expectations
  can be made using:

   ER G   RFR   i R m  RFR 
        Sharpe Portfolio
      Performance Measure

• Risk premium earned per unit of risk



               R i  RFR
     Si 
                     i
   Demonstration of Comparative
        Sharpe Measure
                                    Average Annual Rate of          Standard Deviation of
        Portfolio
                                            Return                         Return
              D                              0.13                              0.18
              E                              0.17                              0.22
              F                              0.16                              0.23

              0.14  0.08                                     0.13  0.08
       SM                 0.300                      SD                 0.278
                 0.20                                            0.18

              0.17  0.08                                      0.16  0.08
       SE                 0.409                      SF                  0.348
                 0.22                                             0.23
•The D portfolio had the lowest risk premium return per unit of total risk, failing
even to perform as well as the aggregate market portfolio. In contrast, Portfolio E
and F performed better than the aggregate market: Portfolio E did better than
Portfolio F.
    Treynor versus Sharpe Measure
• Sharpe uses standard deviation of returns as the
  measure of risk
• Treynor measure uses beta (systematic risk)
• Sharpe therefore evaluates the portfolio manager
  on the basis of both rate of return performance
  and diversification
• The methods agree on rankings of completely
  diversified portfolios
• Produce relative not absolute rankings of
  performance
            Jensen Portfolio
         Performance Measure
• Also based on CAPM
• Expected return on any security or portfolio is

ER j   RFR   j ER m   RFR 
              Jensen Portfolio
           Performance Measure
• Also based on CAPM
• Expected return on any security or portfolio is

ER j   RFR   j ER m   RFR 
Where: E(Rj) = the expected return on security
RFR = the one-period risk-free interest rate
j= the systematic risk for security or portfolio j
E(Rm) = the expected return on the market portfolio of
  risky assets
 Applying the Jensen Measure
• Jensen Measure of performance requires
  using a different RFR for each time interval
  during the sample period
• It does not directly consider the portfolio
  manager’s ability to diversify because it
  calculates risk premiums in term of
  systematic risk
 Jensen Measure and Multifactor
            Models
• Advantages:
  – It is easier to interpret
  – Because it is estimated from a regression equation, it is possible to
    make statements about the statistical significance of the manger’s
    skill level
  – It is flexible enough to allow for alternative models of risk and
    expected return than the CAPAM. Risk-adjusted performance can
    be computed relative to any of the multifactor models:


 R jt  RFRt   j  [b j1F1t  b j 2 F2t                 b jk Fkt ]  e jt
      The Information Ratio
      Performance Measure
• Appraisal ratio
• measures average return in excess of
  benchmark portfolio divided by the standard
  deviation of this excess return

               R j  Rb       ER j     j
      IR j                         
                 ER           ER     U
      Application of Portfolio
      Performance Measures


      EPit  Divit  Cap.Dist.it  BPit
Rit 
                     BPit
       Potential Bias of One-
       Parameter Measures
• positive relationship between the composite
  performance measures and the risk involved
• alpha can be biased downward for those
  portfolios designed to limit downside risk
        Measuring Performance with
          Multiple Risk Factors
  • Form of the estimation equation

R jt  RFRt   j  [b j1 ( RMt  RFRt )  b j 2 SMBt  b j 3 HMLt ]  e jt
        Relationship between
       Performance Measures
• Although the measures provide a generally
  consistent assessment of portfolio
  performance when taken as a whole, they
  remain distinct at an individual level.
• Therefore it is best to consider these
  composites collectively
• The user must understand what each means
   Components of Investment
        Performance
• Fama suggested overall performance, which
  is its return in excess of the risk-free rate
  Overall Performance=Excess return=Portfolio
   Risk + Selectivity
      Components of Investment
           Performance
 • The selectivity measure is used to assess the
   manager’s investment prowess
 • The relationship between expected return
   and risk for the portfolio is:

 
  ˆ
E R  RFR  
                  ˆ           ˆ ˆ    
             E m R  RFR  Cov R j , R m          
                          
               Rm     Rm 
                         
      Evaluating Selectivity
• The market line then becomes a benchmark
  for the manager’s performance
               Rm  RFR 
  R x  RFR             x
                 Rm  

   Selectivit y  Ra  Rx  a 
        Evaluating Diversification
   • The selectivity component can be broken
     into two parts
       – gross selectivity is made up of net selectivity
         plus diversification

Selectivit y                              Diversific ation
Ra  R x  a   Net Selectivit y  R x  Ra   R x  a 
  Holding Based Performance
        Measurement
• There are two distinct advantages to
  assessing performance based on investment
  returns
  – Return are usually easy for the investor to
    observe on a frequent basis
  – Represent the bottom line that the investor
    actually takes away from the portfolio
    manager’s investing prowess
    Holding Based Performance
          Measurement
• Returns-based measures of performance are
  indirect indications of the decision-making
  ability of a manager
• Holdings-based approach can provide
  additional insight about the quality of the
  portfolio manager
       Grinblatt -Titman (GT)
       Performance Measure
• Among the first to assess the quality of the
  services provided by money managers by
  looking at adjustments they made to the
  contents of their portfolios

    GTt      (w
              j
                    jt    w jt 1 )R jt

                              GT      t
      Average GT              t
                                   T
   Characteristic Selectivity (CS)
      Performance Measure
• CS performance measure compares the returns of
  each stock held in an actively managed portfolio
  to the return of a benchmark portfolio that has the
  same aggregate investment characteristics as the
  security in question
     CSt      wj
                     jt ( R jt    RBjt )

                                  CS    t
       Average CS               t
                                     T
Performance Attribution Analysis

                                       
• Allocation effect   i Wai  W pi  R pi  R p
• Selection effect     W   R  R 
                        i   ai     ai    pi
      Performance Attribution
            Extensions
• Attribution methodology can be used to
  distinguish security selection skills from
  any of several other decisions that investor
  might make
 Measuring Market Timing Skills

• Tactical asset allocation (TAA)
• Attribution analysis is inappropriate
  – indexes make selection effect not relevant
  – multiple changes to asset class weightings
    during an investment period
• Regression-based measurement
      Measuring Market Timing Skills
R pt  RFRt  maxRst  RFRt , Rbt  RFRt ,0
R   pt    RFRt      b Rbt  RFRt    s Rst  RFR 
                   maxRst  RFRt , Rbt  RFRt ,0 U t
      Factors That Affect Use of
       Performance Measures
• Market portfolio is difficult to approximate
• Benchmark error
  –   can effect slope of SML
  –   can effect calculation of Beta
  –   greater concern with global investing
  –   problem is one of measurement
• Sharpe measure not as dependent on market
  portfolio
      Benchmark Portfolios
• Performance evaluation standard
• Usually a passive index or portfolio
• May need benchmark for entire portfolio
  and separate benchmarks for segments to
  evaluate individual managers
    Demonstration of the Global
       Benchmark Problem
• Two major differences in the various beta
  statistics:
  – For any particular stock, the beta estimates
    change a great deal over time.
  – There are substantial differences in betas
    estimated for the same stock over the same time
    period when two different definition of the
    benchmark portfolio are employed.
  Implications of the Benchmark
            Problems
• Benchmark problems do not negate the
  value of the CAPM as a normative model of
  equilibrium pricing
• There is a need to find a better proxy for the
  market portfolio or to adjust measured
  performance for benchmark errors
• Multiple markets index (MMI) is major step
  toward a truly comprehensive world market
  portfolio.
      Required Characteristics of
             Benchmarks
•   Unambiguous
•   Investable
•   Measurable
•   Appropriate
•   Reflective of current investment opinions
•   Specified in advance
      Selecting a Benchmark
Must be selected at two levels:
• A global level that contains the broadest
  mix of risky asset available from around
  the world
• A fairly specific level consistent with the
  management style of an individual money
  manager (i.e., a customized benchmark).
            Evaluation of
      Bond Portfolio Performance
 • Returns-Based Bond Performance
   Measurement
       – Early attempts to analyze fixed-income
         performance involved peer group comparisons
       – Peer group comparisons are potentially flawed
         because they do not account for investment risk
         directly.
       – Fama and French addressed the flaw
R jt - RFR t = α j +  b j1  R mt - RFR t  + b j2SMBt + b j3HML t  + b j4TERM t + b j4 DEFt  + e jt
                                                                                             
Bond Performance Attribution
• How did the performance levels of portfolio
  managers compare to the overall bond
  market?
• What factors lead to superior or inferior
  bond-portfolio performance?
Bond Performance Attribution
• A Bond Market Line
  – Need a measure of risk such as beta coefficient
    for equities
  – Difficult to achieve due to bond maturity and
    coupon effect on volatility of prices
  – Composite risk measure is the bond’s duration
  – Duration replaces beta as risk measure in a
    bond market line
Bond Performance Attribution
 • This technique divides the portfolio return that
   differs from the return on the Lehman Brothers
   Index into four components:
    – Policy effect
       • Difference in expected return due to
         portfolio duration target
    – Rate anticipation effect
       • Differentiated returns from changing
         duration of the portfolio
    – Analysis effect
       • Acquiring temporarily mispriced bonds
    – Trading effect
       • Short-run changes
            Reporting Investment
               Performance
• Time-Weighted and Dollar-Weight Returns
   – A better way to evaluate performance regardless of the
     size or timing of the investment involved.
   – The dollar-weighted and time-weighted returns are the
     same when there are no interim investment
     contributions within the evaluation period.
                     Ending Value of Investment
            HPY =                                 -1
                    Beginning Value of Investemnt

               Ending Value of Investment - 1 - DW  Contribution 
Adjusted HPY =                                                        1
               Beginning Value of Investemnt +  DW  Contribution 
        Reporting Investment
           Performance
• Performance Presentation Standards (PPS)
  – The goals of the AIMR-PPS are:
     • achieve greater uniformity and comparability
       among performance presentation
     • improve the service offered to investment
       management clients
     • enhance the professionalism of the industry
     • bolster the notion of self-regulation
          Reporting Investment
             Performance
• Performance Presentation Standards
  – Fundamental principles
     • Total return must be used
     • Time-weighted rates of return must be used
     • Portfolios must be valued at least monthly and periodic returns must
       be geometrically linked
     • Composite return performance (if presented) must contain all actual
       fee-paying accounts
     • Performance must be calculated after deduction of trading expenses
     • Taxes must be recognized when incurred
     • Annual returns for all years must be presented
     • Disclosure requirements must be met
        The Internet
     Investments Online
http://www.nelsons.com
http://www.styleadvisor.com
http://www.morningstar.com
http://www.cfainstitute.org
End of Chapter 25
 –Evaluation of Portfolio
  Performance

				
DOCUMENT INFO
Description: Investment Analysis document sample