Name : Noer Rachmadhani Hernirat

NIM : 1810523011

READING SUMMARY/ REVIEW

CHAPTER 21
All Investors Must Consider Portfolio Management
No Main Topic/ Issues Sub-Topic/ Issues Summarry page
A Perspective on Before investing, each individual should develop an overall financial
568 &
1 Investing in Financial plan. Tax planning is an ongoing important activity because most
569
Assets financial decisions involve taxes one way or the other.
Portfolio Management, Process The second step in the investment
decision process, involving the management of a group of assets
(i.e., a portfolio) as a unit. As part of their financial planning,
investors can view the management of their portfolios within the
following framework.
1) Decide what objectives you wish to accomplish and any
constraints you may face, along with any particular
Managing Your preferences you have. 569 &
2
Financial Assets 2) Determine your expectations for the economy and its sectors. 570
3) Develop a strategy and implement it
4) Keep up with what is going on with your portfolio on an
ongoing basis and be prepared to make changes.
5) Rebalance the portfolio as necessary.
6) As part of their financial planning, investors need to know
how they are doing as investors. Portfolio performance must
be measured and evaluated.
Individual Investors Vary Significant differences exist among investors as to objectives, 570

Widely
Formulate an
3 Appropriate
Investment Strategy
4 Investor Objectives
constraints, and preferences. Individual investors may engage in
direct investing, indirect investing, or a combination of the two.
Investors use differing approaches to the valuation of securities.
Some may believe in efficient markets, while others may attempt to
use the principles of behavioral finance in their investing
activities.Investment Strategy An organized, logical framework
within which to make and execute portfolio decisions.
The first thing investors need to do in managing their portfolios is to
carefully think about what they are trying to achieve, and determine
if their investing goals are reasonable.
 OBJECTIVES:
 return requirements
 risk tolerance
followed by 571
 CONSTRAINTS AND PREFERENCES:
 liquidity
 time horizon
 laws and regulations
 taxes
 unique preferences and circumstances
Portfolio objectives are always going to center on return and risk, 571 &
because these are the two aspects of most interest to investors, and 572
return and risk are the basis of financial decisions.
1) Accumulation Phase In the early stage of the life cycle, net
worth is typically small, but the time horizon is long. Investors
can afford to assume large risks.
2) Consolidation Phase In this phase, involving the mid-to-late
career stage of the life cycle when income exceeds expenses,
an investment portfolio can be accumulated. A portfolio
balance is sought to provide a moderate tradeoff between risk
and return.
3) Spending Phase In this phase, living expenses are covered
 from accumulated assets rather than earned income. While
some risk-taking is still preferable, the emphasis is on safety,
resulting in a relatively low position on the risk-return tradeoff.
4) Gifting Phase In this phase, the attitudes about the purpose of
investments changes.
Inflation Considerations Inflation should be a concern for investors
when thinking about the return requirements for a portfolio.Inflation
typically persists steadily across time, at varying rates, eroding
Establishing Your Return values.Contrary to some people’s beliefs, common stocks are not 572 &
Expectations always an inflationary hedge.Historically, inflation has severely 573
damaged bond performance over long periods of time.Good
financialplanning requires investors to always be aware of
inflationary possibilities and plan accordingly.
Investors should establish a portfolio risk level that is suitable for
them, and then seek the highest returns consistent with that level of
Assessing Your Risk risk.Perhaps the best way to think about investor objectives is to
573
Tolerance think about an investor’s risk tolerance. Investors decide how much
risk they are willing to take, and then attempt to maximize expected
return given this level of risk.
Good financial planning requires individuals to consider how they
would raise cash in an emergency, or in the event that cash was
urgently needed for some purpose. liquidity is the ease with which
an asset can be sold without a sharp change in price as the result of
What Issues Do selling. Obviously, cash equivalents (money market securities) have
5 Investors Face in Their Liquidity Needs high liquidity, and are easily sold at close to face value. Many stocks 574
Financial Planning? also have great liquidity, but the price at which they are sold will
reflect their current market valuations. Investors must decide how
likely they are to sell some part of their portfolio in the short run. As
part of the asset allocation decision, they must decide how much of
their funds to keep in cash equivalents.
Time Horizon The objectives being pursued may require a strategy that speaks to 574
specific planning horizons.time. It is important to note that
 investors’ time horizons have been shortened in today’s world more
than they have ever been. Computer-generated models emphasize
the short term, and turnover rates for portfolios are at record levels.
It appears that many investors are focused on short-term
performance, often to their detriment.
In doing their financial planning, investors should be aware of the
terminology involved with taxes. Individuals often confuse marginal
Tax Considerations tax rates and average tax rates, both of which are progressive. 575
Marginal Tax Rate, The tax rate on the last dollar of income.
Average Tax Rate, Total tax divided by taxable income
Investors must deal with a number of regulations when it comes to
tax-deferred accounts such as IRAs, Keoghs, SEPs, and so forth.
There are strict rules on contribution amounts, and the timing of
Regulations 576
these contributions, as well as on withdrawals. Financial planning is
very important in this area as mistakes—both omission and
commission—can be costly.
Individuals may be able to count on inheritances down the road,
thereby taking some of the financial pressures off of them. Almost
Unique Individual regardless of the various circumstances that individuals may face,
576
Circumstances having a carefully thought out financial plan is important.
Objectives need to be clearly specified, and contingencies planned
for.
6 Investor Expectations Rate Of Return Investors should recognize some key points about future rates of 576
as a Part of Financial Assumptions return. In estimating the expected return on stocks (as proxied by the -579
Planning S&P 500), we can combine the riskless rate and the expected risk
premium for large company stocks. The expected equity risk
premium to be used in this calculation is based on the arithmetic
mean of equity risk premiums and notthe geometric mean because
this is an additive relationship. A second key point that investors
should recognize in thinking about expected rates of return, and the
returns they can realistically expect to achieve, is that common stock
returns involve considerable risk. Jones and Wilson determined from
 a statistical analysis of the data that the historical returns on the S&P
500 Index are lognormally distributed, which means that we can
usecompound rates of return to estimate probabilities based on the
mean and standard deviation of the logs of annual total returns.
These probabilities are calculated and reported as the probabilities of
achieving any specifierd compound annual average rate of return
over any specified holding period.
The asset allocation decision involves deciding the percentage of
investable funds an investor will place in asset classes such as
stocks, bonds, cash equivalents, and so forth. While multiple asset
classes are available, for discussion purposes we can think of the
asset allocation decision in terms of stocks, bonds, and safe assets
(Treasury bills), because most investors hold some or all of these
three asset classes. Asset allocation is the most important investment
decision made by investors because it is the basic determinant of the
Implementing return and risk taken. Having allocated funds to asset classes, an 580 &
7 Asset Allocation
Investing Strategies investor’s fate is largely determined assuming adequate 581
diversification.Important considerations in making the asset
allocation decision include the investor’s return requirements
(current income versus future income), the investor’s risk tolerance,
and the time horizon. This is done in conjunction with the
investment manager’s expectations about the capital markets and
about individual assets.According to some analyses, asset allocation
is closely related to the age of an investor.
This involves the so-called life-cycle theory of asset allocation.
Portfolio construction involves the selection of securities to be
included in the portfolio and the determination of portfolio funds
(the weights) to be placed in each security. the Markowitz model
Portfolio Optimization provides the basis for a scientific portfolio construction resulting in 582
efficient portfolios. the Markowitz model provides an organized
framework for portfolio optimization, which allows investors to
construct portfolios that are efficient.
 An investor’s circumstances can change for several reasons. These
can be easily organized in a systematic manner and include :
 Change in Wealth A change in wealth may cause an investor
to behave differently, possibly accepting more risk in the
case of an increase in wealth, or becoming more risk averse
in the case of a decline in wealth.
 Change in Time Horizon Traditionally, we think of investors
aging and becoming more conservative in their investment
approach.
 Change in Liquidity Requirements A need for more current
Financial Planning on
8 income could increase the emphasis on dividend-paying 582
an Ongoing Basis
stocks, while a decrease in current income requirements
could lead to greater investment in mid-cap and small stocks
whose potential payoff may be years in the future.
 Change in Tax Circumstances An investor who moves to a
higher tax bracket may find municipal bonds more attractive.
Also, the timing of the realization of capital gains can
become more important.
 Change in Regulations Laws affecting investors change
regularly, whether tax laws or laws governing retirement
accounts, annuities, and so forth.
Tax-Advantaged For taxable investors, the impact of taxes should play an important 583
Investing part in their portfolio management strategy. Too often tax
considerations are an after-thought, or are handled on an ad hoc
basis. Taxes can easily have a larger impact than any other costs
associated with a portfolio of securities. A simple approach to tax-
advantaged investing traditionally was to choose a portfolio of
growth stocks that would be held for a multiple year period. These
stocks generally pay minimal or no dividends, thereby escaping the
higher taxation associated with dividends. Some mutual funds strive
for tax efficiency. Of course, index funds by nature are tax efficient
because their only portfolio changes occur when the underlying
 index changes. Some actively managed funds also seek to be tax
efficient by keeping turnover low, minimizing the capital gains that
are realized.
Individuals should monitor market conditions to the extent possible.
Financial decisions are made in a dynamic marketplace where
change occurs on a continuing basis. Key macro variables, such as
Monitoring Market
inflation and interest rates, should be tracked on a regular basis. 583
Conditions
Whether individuals plan to buy a house, borrow money for various
purposes, invest in various assets, and so forth, they need to be
aware of what is going on in the financial marketplace.
Individual investors, having taken the time to make the asset
allocation decision, need to recognize that their chosen asset
allocation percentages will likely get out of alignment over time.
They often forget to rebalance their portfolios. This means that they
Rebalancing a may lose the benefits of having an asset allocation plan. Rebalancing
584 &
9 Portfolio of Financial reduces the risks of sharp losses—in general, a rebalanced portfolio
585
Assets is less volatile than one that is not rebalanced.Rebalancing is
difficult for many investors because it represents a contrarian
strategy. To rebalance, investors are selling those asset classes that
have appreciated, and reinvesting the funds in those that have not.
This is very difficult to do psychologically.
10 Determining the The financial planning process is designed to facilitate making 585
Success of Your investment decisions in an organized, systematic manner. Clearly, it
Financial Planning is important to evaluate the effectiveness of the overall decision-
making process. One very important part of this is to measure the
performance of the portfolio of financial assets. This allows
investors to determine the success of both their direct investments
and their indirect investments in mutual funds and ETFs. It is a key
part of monitoring one’s overall financial planning. Performance
measurement is important to both those who employ a professional
portfolio manager on their behalf as well as to those who invest
personal funds. It allows investors to evaluate the risks that are
 being taken, the reasons for the success or failure of the investing
program, and the costs of any restrictions that may have been placed
on the investment manager.
Having an orderly process identifies the issues that are of
importance to investors such as expectations about the future, taxes,
portfolio rebalancing, and so forth. Passive investing in the form of
Minimize Costs and
index funds and some ETFs is the way to go for most investors.
Effort, and Improve
Take a long-run approach, make a reasonable asset allocation
Performance,
11 decision, use index funds and ETFs, and enjoy the benefits of low 585
When Managing a
costs, low taxes, and diversification. Plan to match the performance
Portfolio of Financial
of the overall markets in which you are invested. Surprising as it
Assets
may be to many people, such a strategy would allow most investors
to outperform their friends and contemporaries over a long period of
time
Name : Noer Rachmadhani Hernirat
NIM : 1810523011

READING SUMMARY/ REVIEW

CHAPTER 22
Evaluation of Investment Performance: A Global Concept
No Main Topic/ Issues Sub-Topic/ Issues Summarry page
We will consider four broad issues in evaluating portfolio
performance:
1. Performance Measurement Issues—The critical concern for
most investors is to correctly determine how a portfolio
performed over some period of time.
2. Well-Known Measures of Performance—Several risk-
adjusted measures of portfolio performance have been
A Framework for
available for many years.
Evaluating and
1 3. Performance Attribution and Style Analysis—Going beyond 592
Assessing
measuring a portfolio’s performance, the concept of
Portfolio Performance
performance attribution seeks to determine why a portfolio
had the rate of return it did over some specified period of
time.
4. 4. Portfolio Presentation Standards—How should the actual
results of a portfolio be presented to those directly affected
by that portfolio—in other words, from investment manager
to client?.
2 Performance Three Questions To To evaluate portfolio performance properly, we must determine 593 &
Measurement Issues Answer In Measuring whether the returns are large enough given the risk involved. If we 594
Portfolio Performance are to assess portfolio performance correctly, we must evaluate
 performance on a risk-adjusted basis. It is critical in evaluating
portfolio performance to compare the returns obtained on the
portfolio being evaluated with the returns that could have been
obtained from a comparable alternative. Benchmark Portfolio, An
alternative portfolio against which to measure a portfolio’s
performance. The S&P 500 has been the most frequently used
benchmark for evaluating the performance of institutional portfolios
such as those of pension funds and mutual funds. However, many
observers now agree that multiple benchmarks are more appropriate
to use when evaluating portfolio returns. Customized benchmarks,
explained later in the chapter, also can be constructed to more
accurately evaluate a manager’s style.
The market value of a portfolio can be measured at the beginning
and ending of a period, and the rate of return can be calculated as :

where ,
VE is the ending value of the portfolio and VB is its beginning value.
This calculation assumes that no funds were added to or withdrawn
from the portfolio by the client during the measurement period. If
such transactions occur, the portfolio return as calculated, Rp, may
not be an accurate measure of the portfolio’s performance. Dollar- 595
Return Calculations
Weighted Rate of Return (DWR), Equates all cash flows, including -597
ending market value, with the beginning market value of the
portfolio. The DWR measures the rate of return to the portfolio
owner; that is, it accurately measures the investor’s return. Time-
Weighted Rate of Return (TWR), Measures the actual rate of return
earned by the portfolio manager. In order to evaluate a manager’s
performance properly, we should use the time-weighted rate of
return. The time-weighted return captures the rate of return actually
earned by the portfolio manager, while the dollar-weighted return
captures the rate of return earned by the portfolio owner.
 The two prevalent measures of risk used in investment analysis are
total risk and nondiversifiable, or systematic, risk. Total risk is
measured by calculating the standard deviation, and systematic risk
—that part of total risk that cannot be diversified away—isassessed
by considering the beta for the portfolio. Differences in risk will
cause portfolios to respond differently to changes in the overall
597 &
Risk Considerations market and should be accounted for in evaluating
598
performance.Coefficient of Determination, The square of the
correlation coefficient, measuring the percentage of the variance in
the dependent variable that is explained by the independent variable.
The coefficient of determination indicates the percentage of the
variance in the portfolio’s returns that is explained by the market’s
returns.
What constitutes a good universe or benchmark for the evaluation of
portfolio performance? Characteristics that have been identified
include the following
Performance  Unambiguous 598 &
Benchmarks And
 Specified in advance 599
Performance Universes
 Appropriate
 Investable
 Measurable
Performance Universe Constructed by aggregating market
Performance Universes valuations and income accruals for a large number of portfolios that 599
are managed individually.
Performance Performance Benchmarks Unmanaged, passive portfolios that reflect
599
Benchmarks a manager’s investment style
A Straightforward Investors today hold various combinations of domestic and foreign 600
Approach To stocks, large-cap stocks and small-cap stocks, different varieties of
Performance bonds, TIPS, and other assets. Each of these asset classes should be
Evaluation evaluated relative to a proper benchmark. ETFs and index funds can
be used effectively in many cases as benchmarks. There are several
choices among the various fund companies for ETFs that could be
 used; because Vanguard ETFs often have extremely low expenses,
we will cite several of their funds. Keep in mind there are multiple
alternative in most cases.s. If you hold Treasury and corporate
bonds, you can use Vanguard’s Total Bond Market ETF as a
benchmark. If your bond holdings are limited to one or the other,
Vanguard has ETFs devoted to each, which can be further broken
down to long-term and short-term corporate or Treasury ETFs. If
you hold emerging markets stocks or funds, Vanguard’s MSCI
Emerging Market ETF could serve as a benchmark, as could
Fidelity’s Emerging Markets Fund.
3 Risk-adjusted The Sharpe Rat Sharpe Ratio, A measure of portfolio performance calculated as the 600 –
Measures of ratio of excess portfolio return to the standard deviation. This 602
Performance measure, sometimes called the Reward to Variability (RVAR) Ratio,
can be defined as

TR´ p = the average TR for portfolio p during some period of time

(we will use annual data)
´ = he average risk-free rate of return during the periodthe
RF
SDP= standard deviation of return for portfolio p during the period
TR´ p - RF
´ = the excess return (risk premium) on portfolio p

Note the following about the Sharpe ratio:

1) It measures the excess return per unit of total risk (standard
deviation).
2) The higher the calculated value, the better the portfolio
performance.
3) Portfolios can be ranked using the Sharpe ratio. Using only
the Sharpe ratio as our measure of portfolio performance, we
would judge the portfolio with the highest calculated value
 best in terms of ex post performance.
At approximately the same time as Sharpe’s measure was developed
(the mid-1960s), Jack Treynor presented a similar measure. Treynor,
however, distinguished between total risk and systematic risk,
implicitly assuming that portfolios are well diversified; that is, he
Treynor’s Reward To
ignored any diversifiable risk. Thus, Treynor’s measure has the 602
Volatility
same numerator as the Sharpe ratio, but uses beta in the denominator
as the measure of risk. He used as a benchmark the ex post security
market line. Treynor’s measure, sometimes called the reward to
volatility measure.
Jensen’s Alpha Alpha, The difference between an independently determined 603 –
expected rate of return on a stock and the required rate of return on 605
that stock.

Where,
Rpt = the return on portfolio p in period t
RFt = the risk-free rate in period t
Rmt = the return on the market in period t
Ept = a random error term for portfolio p in period t
[ Rmt – RFt ] = the market risk premium during period t

The risk premium on portfolio p is equal to the product of its beta

and the market risk premium plus an error term. In other words, the
risk premium on portfolio p should be proportional to the risk
premium on the market portfolio if the CAPM model is correct and
 investor expectations were generally realized. where αp is the alpha
or intercept term:

Where the bars above the variables indicate averages for the period
measured.It is important to recognize the role of statistical
significance in the interpretation of Jensen’s measure. Although the
estimated alpha may be positive or negative, it may not be
significantly different (statistically) from zero. If it is not, we would
conclude that the manager of the portfolio being evaluated
performed as expected.Portfolios often fail to meet this statistical
significance test because of the variability in security returns. This
means that if the manager does actually add value, it cannot be
detected statistically.
M2 A big advantage of M2 is that the results are stated in decimal or 606 &
percentage form. 607

Where,
σ M = standard deviation of the market
σ p = standard deviation of the portfolio being measured
Rp = the return on the portfolio whose performance is being
measured

M2 produces a percentage return which can be easily understood. It

produces the same rankings as the Sharpe measure.Jensen’s alpha
uses beta as the measure of risk. Jensen’s measure is not suitable for
ranking portfolio performance, but it can be modified to do so. The
Jensen and Treynor measures can produce, with proper adjustments,
 identical relative rankings of portfolio performance.
Style Analysis, A classification reflecting a portfolio manager’s
“style” characteristics There are two approaches to style analysis,
returns-based and holdings-based:
 l Holdings-based style analysis uses the stocks in a portfolio
to describe a fund’s allocation among asset classes or equity
Style Analysis and styles.
607 &
4 Performance Style Analysis  Returns-based style analysis compares a portfolio’s return to 608
Attribution the returns generated by a set of market indexes, each of
which tracks a specific investment style such as large-cap
growth or small-cap value.
Using a returns-based style analysis, a manager’s style reflects only
an analysis of the components of a portfolio’s actual return behavior,
making it an objective method for determining risk exposure.
Performance Attribution, A part of portfolio evaluation that seeks
Performance to determine why success or failure occurred. Another way to think
Attribution A Part Of about performance attribution is to recognize that performance
Portfolio Evaluation That different from a properly constructed benchmark comes from one of
609
Seeks To Determine two sources, or both:
Why Success Or Failure
 Market timing
Occurred.
 Security selection
5 Money Managers and These Performance Presentation Standards (PPS) were a set of 610
Performance guiding ethical principles with two objectives:
Presentations  To promote full disclosure and fair representation by
investment managers in reporting their investment results.
 To ensure uniformity in reporting in order to enhance
comparability among investment Managers.
Global Investment Performance Standards (GIPS), A global
standard used for the fair presentation of portfolio performance and
for ensuring accuracy and consistency of data in record keeping,
marketing, and presentation. GIPSs requirements include:
a. Uniformity in certain performance calculations and
 disclosures
b. Inclusion of all actual fee-paying discretionary portfolios in
composites that have a similar objective
c. Compliant history for at least five years, or since inception if
less than five years.
Investors can use several well-known techniques to assess the actual
performance of a portfolio relative to one or more alternatives. In
the final analysis, when investors are selecting money managers to
turn their money over to, they evaluate these managers only on the
basis of their published performance statistics. If the published
An Overview on
“track
6 Performance 611
record” looks good, that is typically enough to convince many
Evaluation
investors to invest in a particular mutual fund. However, the past is
no guarantee of an investment manager’s future. Short-term results
may be particularly misleading. Finally, note that a long evaluation
period is needed to successfully determine performance that is truly
superior.