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Introduction
1. Time-weighted returns
2. Dollar-weighted returns
Time-weighted returns
1 rG
n
1 r1 1 r2 ...1 rn
Dollar-weighted returns
• Internal rate of return considering the
cash flow from or to investment
• Returns are weighted by the amount
invested in each period:
C1 C2 Cn
PV ...
1 r 1 1 r 2 1 r n
Dollar-Weighted Return
$2 $4+$108
-$50 -$53
51 112
50
(1 r ) (1 r ) 2
1
r 7.117%
INVESTMENTS | BODIE, KANE, MARCUS
24-11
Time-Weighted Return
53 50 2
r1 10%
50
54 53 2
r2 5.66%
53
rG = [ (1.1) (1.0566) ]1/2 – 1 = 7.81%
Information Ratio
Ri=γi+βRm+ei
2
M Measure
• Developed by Modigliani and
Modigliani
• Create an adjusted portfolio (P*)that
has the same standard deviation as
the market index.
• Because the market index and P*
have the same standard deviation,
their returns are comparable:
M rP* rM
2
2
M Measure: Example
Managed Portfolio: return = 35% standard deviation = 42%
Market Portfolio: return = 28% standard deviation = 30%
T-bill return = 6%
P* Portfolio:
30/42 = .714 in P and (1-.714) or .286 in T-bills, then P* will have same
standard deviation as market. R(P*)=.714 X R(P)+.286 X R(T-bills).
σ(R(P*))=.714σ(R(P))=.714X42=30= standard deviation of market
The return on P* is R(P*)= (.714) (.35) + (.286) (.06) = 26.7%
Since this return is less than the market, the managed portfolio
underperformed.
2
Figure 24.2 M of Portfolio P
(rP rf )
P
2) If the portfolio is one of many combined into a larger investment
fund, use the Jensen or the Treynor measure. The Treynor
measure is appealing because it weighs excess returns against
systematic risk.
Expected
Return, rp
CML
I2
I1
^
rM
^
rR
.
R . M
R = Optimal
rRF Portfolio
R M Risk, p
Market Timing
• In its pure form, market timing involves shifting
funds between a market-index portfolio and a safe
asset (D is a dummy below and =1 if rm>rf and 0
otherwise). (use slide 2, return of S&P 500 index
as an example)
• Treynor and Mazuy:
rP rf a b(rM rf ) c(rM rf ) eP 2
Style Analysis
• Introduced by William Sharpe
• Regress fund returns on indexes representing a
range of asset classes.
• R(index)=α+β1Xasset class 1+ β2Xasset class 2 +… +error
• The regression coefficient on each index
measures the fund’s implicit allocation to that
“style.”
• R –square measures return variability due to style
or asset allocation.
• The remainder is due either to security selection
or to market timing.
Performance Attribution
• A common attribution system decomposes
performance into three components:
Attributing Performance to
Components
Attributing Performance to
Components
(w
i 1
pi pi r wBi rBi )
Performance Attribution
• Superior performance is achieved by:
– overweighting assets in markets that
perform well
– underweighting assets in poorly
performing markets