Financial Markets and Investments

Module Portfolio Performance Evaluation

Session No. III

Version 1.0
 Financial Markets and Investments

Material from the published or unpublished work of others which is referred to in the Class
Notes is credited to the author in question in the text. The Class Notes prepared is of 940
words in length. Research ethics issues have been considered and handled appropriately
within the Globsyn Business School guidelines and procedures.

FM&I/M7S3/v1.0/030320 Portfolio Performance Evaluation | Session No.III

 Financial Markets and Investments

Table of Contents

1. Risk Measurement..................................................................................................... 4

2. Determination of Beta ............................................................................................... 4

3. Correlation Coefficient .............................................................................................. 8

References ..................................................................................................................... 9

List of Figures and Tables

Figure 2.1: Mutual Fund and Nifty Returns ................................................................................. 5

Table 2.1: Calculation of Different Variables .............................................................................. 6

Figure 2.2: Determination of Correlation Coefficient ................................................................... 6

FM&I/M7S3/v1.0/030320 Portfolio Performance Evaluation | Session No.III

 Financial Markets and Investments

1. Risk Measurement
Risk in investment is associated with the return. The notable point is that whenever an investor
considers the risk that risk must have a corresponding return. Without return, there is no
existence of risk. The investors may measure the expected return of the investment. This
measurement considers a probable weighted average of all the possible returns. Since the
return is connected with risk so we have to measure the corresponding risk related to the return.
While measuring such risk, the variability of possible returns is required to be measured to
calculate standard deviation therefrom. The standard deviation is called the total risk associated
with the investment. The variance or standard deviation gives variability. The widely used
procedure for assessing risk is known as the mean-variance approach. The total risk comprises
of two elements. These are systematic risk or undiversified risk and unsystematic risk or unique
risk. Systematic risk is related to the macro factors (CFI, 2020). Whereas, unsystematic risk is
associated with micro factors. These micro factors can be eliminated in the long term. However,
macro factors like interest rate risk, Government policy, inflation are the economic factors that
affect the market unceasingly due to change over the period. The systematic risk is measured
through beta coefficient. It is a sort of sensitivity that measures change in security return relative
to the movement of the corresponding market index. An investor always thinks of the risk
before making any investment decision. Two statistical method is used in determining beta.
These are the correlation method and the regression method. The correlation coefficient may
range from -1 to +1. The former one indicates a perfect negative correlation between security
returns, while the latter indicates perfect positive correlations between the security returns. A
value close to zero indicates the returns are independent.

2. Determination of Beta
The systematic risk can be determined by analysing the returns of the portfolio as well as the
corresponding market index. The following data are taken from the recognised website
regarding various returns of SBI Blue-chip Fund on different periods.(Statistics How to, 2020).
Simultaneously, the Nifty returns are also taken for the same period. Please go through the
following example.

Example:

SBI Blue-chip Fund is a Large-cap scheme that invests in stocks of very large companies.
Large-cap schemes are considered less volatile than other equity schemes like mid and small-

FM&I/M7S3/v1.0/030320 Portfolio Performance Evaluation | Session No.III

 Financial Markets and Investments

cap schemes. They are recommended to conservative equity mutual fund investors with an
investment horizon of five to seven years. They offer modest returns.

Regarding the degree of safety of the equity funds, all equity mutual fund schemes, including
large-cap schemes, carry risk as they invest in stocks. However, stocks are considered ideal to
invest in long-term goals as they have the potential to offer superior returns than other assets. If
an investoris ready to hold the investment for a long period, he can hope to get superior after-
tax returns. Try to link the investment to a long-term goal should be valuable for any investor.
Also, keeping track of the performance of the scheme by comparing its performance with its
benchmark index and category is also necessary for every investor.

Figure 2.1: Mutual Fund and Nifty Returns

(Money Control, 2020)

FM&I/M7S3/v1.0/030320 Portfolio Performance Evaluation | Session No.III

 Financial Markets and Investments

Calculate beta of SBI Blue-chip Fund.

Solution:
Table 2.1: Calculation of Different Variables

SBI Return-dependent Variable and Nifty-Independent Variable

Sl . No SBI-Return Nifty-Return
Y X Y² X² YX
1 5.05 7.12 25.50 50.69 35.96
2 -1.96 -3.3 3.84 10.89 6.47
3 2.95 1.68 8.70 2.82 4.96
4 5.08 6.96 25.81 48.44 35.36
5 1.15 -1.32 1.32 1.74 -1.52
6 -2.42 3.29 5.86 10.82 -7.96
7 0.92 4.36 0.85 19.01 4.01
8 -3.62 -2.14 13.10 4.58 7.75
9 8.32 5.84 69.22 34.11 48.59
10 2.64 2.54 6.97 6.45 6.71
11 4.04 3.06 16.32 9.36 12.36
12 12.58 12.16 158.26 147.87 152.97
Total 34.73 40.25 335.75 346.79 305.64

(PreMBA Finance, 2020)

Formula of Correlation

Figure 2.2: Determination of Correlation Coefficient

(Statistics How to, 2020)

Here X is market index return (Nifty) and Y is the return of the item (Return-SBI blue-chip)

n ⅀xy − ⅀y⅀x
We know r =
√n⅀𝑦 2 −(⅀y)2 n⅀x2 −(⅀x)²

FM&I/M7S3/v1.0/030320 Portfolio Performance Evaluation | Session No.III

 Financial Markets and Investments

12 ⅀305.64 −( ⅀ 34.73 ⅀ 40.25)

=
√[12⅀346.79−(40.25)2 ][ 12⅀335.75 −(34.73)2 ]

3667.68−1397.88
=
√( 4161.48−1620.06)×(4029− 1206.17)

2269.8
=
√( 2541.42)×(2822.87)

2269.8
=
2678.73

= .847

Calculation of Variance of Nifty (X)

𝑁⅀𝑋 2 −(⅀𝑋)²
We know that σ²m = 𝑁²

12 ×346.79−(40.25)²
= 12 ×12

2541.42
= 144

= 17.64

σm = 4.2 ---------- Standard deviation

Calculation of Variance of Mutual Fund Return

𝑁⅀𝑌 2 −(⅀𝑌)²
σ²i= 𝑁²

12 ×335.75−(34.73)²
= 12 ×12

2822.87
= 12 ×12

= 19.60

σi = 4.42 ----------------- Standard deviation

𝑟¡ₘ 𝜎¡ 𝜎ₘ
Beta βi =
𝜎²ₘ

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 Financial Markets and Investments

.847 ×4.2 ×4.42

=
17.64

= .89

It is generally observed that cyclical firms are expected to have a higher beta in comparison to
non-cyclical firms. Where a firm maintains discretionary production level, the beta is generally
high for such a firm. On the other hand, a firm that provides basic necessities has a lower beta.

3. Correlation Coefficient
The strength of the relationship between two securities is measured through a certain statistical
process called coefficient of correlation. Another very important factor is covariance. The
Covariance is a measure of how returns co-vary with each other. Variance refers to the
variations in returns of the security with itself. The difference between standard deviation and
covariance is - the former measures the variation of individual security while the latter measures
the variation of two securities. Coefficient of correlation is determined by dividing the covariance
of Return 1 and Return 2 by the product of the standard deviations (Statistics How to, 2020).

𝐶𝑜𝑣 (𝑅₁, 𝑅₂)

Correlation Coefficient =
𝜎₁𝜎₂

However, through regression theory correlation can also be measured. In the earlier section, the
correlation coefficient has been ascertained by using regression formula. Where, the Market
index is an independent variable and mutual fund return is considered as the dependent
variable generally follows the path of passive portfolio management.(PreMBA Finance, 2020).

It has already been stated that Coefficient Correlation can have the value ranging from

1 to -1. It may be close to zero also.

FM&I/M7S3/v1.0/030320 Portfolio Performance Evaluation | Session No.III

 Financial Markets and Investments

References
CFI, 2020. Risk and Return. [Online]

Available at: https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/risk-

and-return/

[Accessed 03 03 2020].

Money Control, 2020. SBI Blue Chip Fund - Growth. [Online]

Available at: https://www.moneycontrol.com/mutual-funds/nav/sbi-blue-chip-

fund/returns/MSB079

[Accessed 03 03 2020].

PreMBA Finance, 2020. Risk and Return: Variance and Standard Deviation. [Online]

Available at: http://ci.columbia.edu/ci/premba_test/c0332/s6/s6_4.html

[Accessed 03 03 2020].

Statistics How to, 2020. Correlation Coefficient: Simple Definition, Formula, Easy Steps. [Online]

Available at: https://www.statisticshowto.datasciencecentral.com/probability-and-

statistics/correlation-coefficient-formula/

[Accessed 03 03 2020].

FM&I/M7S3/v1.0/030320 Portfolio Performance Evaluation | Session No.III