PORTFOLIO PERFORMANCE

EVALUATION - TREYNOR &

JENSENS MEASURE
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PREPARED BY:
PIYUESH PANDEY (B52)
AMAN SINGHAL(B35)
JYOTI PRAKASH ROUT (B27)
ZAIN UL ABDEEN (B61)
SAMIR CHAWLA (B31)

MEASURES OF RETURN
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MEASURES OF RETURN

complicated by addition or withdrawal of money by the

investor
percentage change is not reliable when the base amount may
be changing
timing of additions or withdrawals is important to
measurement

MAKING RELEVANT COMPARISONS

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PERFORMANCE

should be evaluated on the basis of a relative and not an

absolute basis

this is done by use of a benchmark portfolio

BENCHMARK PORTFOLIO

should be relevant and feasible

reflects objectives of the fund
reflects return as well as risk

ARITHMETIC V. GEOMETRIC AVERAGES

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GEOMETRIC MEAN FRAMEWORK

GM = ( HPR)1/N 1

ARITHMETIC V. GEOMETRIC AVERAGES

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GEOMETRIC MEAN FRAMEWORK

measures past performance well

represents exactly the constant rate of return needed to earn in
each year to match some historical performance

ARITHMETIC V. GEOMETRIC AVERAGES

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ARITHMETIC MEAN FRAMEWORK

provides a good indication of the expected rate of return for an

investment during a future individual year
it is biased upward if you attempt to measure an assets longrun performance

RISK-ADJUSTED MEASURES OF
PERFORMANCE
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THE REWARD TO VOLATILITY RATIO (TREYNOR

MEASURE)

There are two components of risk

risk associated with market fluctuations

risk associated with the stock

Characteristic Line (ex post security line)

defines the relationship between historical portfolio returns and

the market portfolio

TREYNOR MEASURE
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TREYNOR MEASURE
Formula

RVOL p

where

arp arf

arp = the average portfolio return

arf = the average risk free rate
p= the slope of the characteristic
line during the time period

TREYNOR MEASURE
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THE CHARACTERISTIC LINE

arp

SML

TREYNOR MEASURE
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CHARACTERISTIC LINE

slope of CL

measures the relative volatility of portfolio returns in relation to

returns for the aggregate market, i.e. the portfolios beta
the higher the slope, the more sensitive is the portfolio to the
market

TREYNOR MEASURE
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THE CHARACTERISTIC LINE

arp

SML

THE SHARPE RATIO

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THE REWARD TO VARIABILITY (SHARPE RATIO)

measure of risk-adjusted performance that uses a benchmark

based on the ex-post security market line

total risk is measured by

THE SHARPE RATIO

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SHARPE RATIO

formula:

SR p
where

arp ar f

SR = the Sharpe ratio

p = the total risk

THE SHARPE RATIO

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SHARPE RATIO

indicates the risk premium per unit of total risk

uses the Capital Market Line in its analysis

THE SHARPE RATIO

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arp

CML

THE JENSEN MEASURE OF PORTFOLIO

PERFORMANCE
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BASED ON THE CAPM EQUATION

E (ri ) RFR [ E (rm ) RFR]

measures the average return on the portfolio over and above

that predicted by the CAPM
given the portfolios beta and the average market return

THE JENSEN MEASURE OF PORTFOLIO

PERFORMANCE
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THE JENSEN MEASURE

known as the portfolios alpha value

recall the linear regression equation

y = + x + e

alpha is the intercept

THE JENSEN MEASURE OF PORTFOLIO

PERFORMANCE
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DERIVATION OF ALPHA

Let the expectations formula in terms of realized rates of

return be written

subtracting RFR from both sides

R jt RFRt j Rmt RFRt u jt

R jt RFRt j Rmt RFRt u jt

THE JENSEN MEASURE OF PORTFOLIO

PERFORMANCE
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DERIVATION OF ALPHA

in this form an intercept value for the regression is not

expected if all assets are in equilibrium
in words, the risk premium earned on the jth portfolio is equal
to j times a market risk premium plus a random error term

THE JENSEN MEASURE OF PORTFOLIO

PERFORMANCE
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DERIVATION OF ALPHA

to measure superior portfolio performance, you must allow for

an intercept
a superior manager has a significant and positive alpha
because of constant positive random errors

COMPARING MEASURES OF PERFORMANCE

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TREYNOR V. SHARPE

SR measures uses as a measure of risk while Treynor uses

SR evaluates the manager on the basis of both rate of return
performance as well as diversification

COMPARING MEASURES OF PERFORMANCE

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for a completely diversified portfolio

SR and Treynor give identical rankings because total risk is really

systematic variance
any difference in ranking comes directly from a difference in
diversification

CRITICISM OF RISK-ADJUSTED
PERFORMANCE
MEASURES
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Use of a market surrogate

Roll: criticized any measure that attempted to model the market

portfolio with a surrogate such as the S&P500
it is almost impossible to form a portfolio whose returns
replicate those over time
making slight changes in the surrogate may completely change
performance rankings

CRITICISM OF RISK-ADJUSTED
PERFORMANCE MEASURES
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measuring the risk free rate

using T-bills gives too low of a return making it easier for a

portfolio to show superior performance
borrowing a T-bill rate is unrealistically low and produces too high
a rate of return making it more difficult to show superior
performance

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Thank you