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Sharpe, Treynor, And Jensen Ratio

Sharpe, Treynor, And Jensen Ratio

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Published by: negm88 on Aug 29, 2010
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Sharpe, Treynor, Jensen

SHARPE, TREYNOR AND JENSEN'S RATIOS SHARPE RATIO This ratio measures the return earned in excess of the risk free rate (normally Treasury instruments) on a portfolio to the portfolio's total risk as measured by the standard deviation in its returns over the measurement period. Or how much better did you do for the risk assumed. S = Return portfolio- Return of Risk free investment Standard Deviation of Portfolio Example: Let's assume that we look at a one year period of time where an index fund returned 11% Treasury bills earned 6% The standard deviation of the index fund was 20% Therefore S = 11-6/.20 = 25 The Sharpe ratio is an appropriate measure of performance for an overall portfolio particularly when it is compared to another portfolio, or another index such as the S&P 500, Small Cap index, etc. That said however, it is not often provided in most rating services. TREYNOR RATIO This ratio is similar to the above except it uses beta instead of standard deviation. It's also known as the Reward to Volatility Ratio, it is the ratio of a fund's average excess return to the fund's beta. It measures the returns earned in excess of those that could have been earned on a riskless investment per unit of market risk assumed. T = Return of Portfolio - Return of Risk Free Investment Beta of Portfolio The absolute risk adjusted return is the Treynor plus the risk free rate. Assume two portfolios A B

http://www.efmoody.com/investments/sharperatio.html (1 of 3) [11/14/2009 8:08:11 PM]

html (2 of 3) [11/14/2009 8:08:11 PM] . However. Caveats apply however since it will only produce meaningful results if it is used to compare two portfolios which have similar betas.000 HP employees who owned considerable sums of mutual funds in 401(k) plans).I do not suggest they put all the money into either one.7 1. It is information.12 = 13..07 Tb= .09 = .14 . when you point out the risk adjusted rate of return. many adjust their thinking.04 Risk adjusted rate of return of Portfolio B = 0.04 + .12 . now which is better? You don't even need to do the formula for that analysis. It measures the ability of active management to increase returns above those that are purely a reward for bearing market risk.09 = . the advice is implied. Many bond funds had earned 13 %.09 = 0. if you ask them what is the better number (12% or 14%) almost universally they state 14%. Jensen Return 12 14 Beta . But if you give really good information.efmoody. For clarification. But that is missing in almost all reviews by all brokers. Treynor.i.just that they need to be aware of the implications.043 Risk adjusted rate of return of Portfolio A = . Assume Two Portfolios http://www.Sharpe.043+ . The example I used was for 1990 .3% . But if I then state that the bond funds had about half the market risk. not advice per se. beta.. Which is better? In absolute numbers.1993 (roughly) where Fidelity Magellan had earned about 18%. JENSEN'S ALPHA This is the difference between a fund's actual return and those that could have been made on a benchmark portfolio with the same risk.2 For many investors. 18% beats 13%. without any analysis of risk.13 = 13% 1.com/investments/sharperatio.09 = .e.2 Risk Free Rate= 9% Ta= . (I did this with about 1.

.Expected Return= . http://www.7 (.11 Alpha = Return of Portfolio.. But if taken out of context. Jensen A Return Beta Risk Free Rate +9% 12 . Alphas are found in many rating services but are not always developed the same way.02 = .09) = . Treynor.12 . the expected return = .in other words a computer sector fund A to computer sector fund b.com/investments/sharperatio.Risk Free Return) Using Portfolio A.0 The return expected= Risk Free Return + Beat portfolio (Return of Market .three year are more preferable. However I have usually found that their relative position in the particular rating service to be viable.7 B 14 1.09 + .I think it is a viable number.so you can't compare an alpha from one service to another.01 = 1% As long as "apples are compare to apples".12 . Short term alphas are not valid.2 Market Return 12 1. Minimum time frames are one year. it loses meaning.09 + .html (3 of 3) [11/14/2009 8:08:11 PM] .efmoody.11 = .Sharpe.

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