CHAPTER 10

MANAGED PORTFOLIO
MEASUREMENT
Table of Contents
MANAGED PORTFOLIO MEASUREMENT .......................................................................... 111
Table of Contents .................................................................................................................... 111
Chapter Overview .................................................................................................................... 112
Learning objectives: ................................................................................................................ 112
10.1 Sharpe’s Performance Index........................................................................................ 112
10.2 Treynor’s Performance Index ...................................................................................... 113
10.3 Jensen’s Performance Index ........................................................................................ 114
Checklist .................................................................................................................................. 117
Study Questions ....................................................................................................................... 118

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Chapter 10 Managed portfolio measurement

Chapter Overview

Managed Portfolio Measurement

Sharpe's Performance Index

Treynor's Performance Index

Jensen's Performance Index

Learning objectives:

After studying this chapter, you should be able to:

1. Evaluate portfolio performance using Treynor's measure

2. Evaluate portfolio perfomance using Sharpe's Measure
3. Differentiate between Treynor and Sharpe portfolio performance measures.
4. Describe how Jensen portfolio performance measure relate to the Treynor measure

10.1 Sharpe’s Performance Index

Sharpe has attempted to get a summary measure of portfolio performance. His measure properly
adjusts performance for risk. The Sharpe Index as follow:

Sp = r - rf
σ

where , Sp is Sharpe Index, r average return on portfolio, rf risk-free rate and σ standard
deviation of the return of portfolio.

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Example.

Given the following data:

Funds Ave. return Std. Deviation

1st Fund 16 22
2nd Fund 10 15
3rd Fund 8 12
4th Fund 14 17

Measure the performance on each fund and rank them according to Sharpe’s Performance Index.
Assume risk-free rate is 5%.

Sp = r - rf
σ
Sp (1st) = (16 – 5)/22 = 0.5

Sp (2nd) = (10 – 5)/15 = 0.33

Sp (3rd) = (8 – 5)/12 = 0.25

Sp (4th) = (14 – 5)/17 = 0.53

Ranking : 1. 4th Fund 2. 1st Fund 3. 2nd Fund 4. 3rd Fund

10.2 Treynor’s Performance Index

Treynor has propose incorporating various concept into a single-index to measure portfolio
performance. This index is given by the following equation:

Tp = r - rf
β

where Tp is the Treynor index, r average return on the portfolio, rf risk-free rate and β beta
coefficient of portfolio.

Example.

Funds Ave. return Beta

Growth 12 1.2
Balance 8 1.5
Income 10 0.9
Special 15 1.7

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Measure the performance on each fund and rank them according to Sharpe’s Performance Index.
Assume risk-free rate is 5%.

Tp = r - rf
β

Tp (Growth) = (12 – 5)/1.2 = 5.83

Tp (Balance) = (8 – 5)/1.5 = 2

Tp (Income) = (10 – 5)/0.9 = 5.56

Tp (Special) = (15 – 5)/1.7 = 5.88

Ranking : 1. Special 2. Growth 3. Income 4. Balance

10.3 Jensen’s Performance Index

Jensen's alpha is the intercept from the following time series regression :

rp - rf = αp + βp ( rm - rf )

where rp is the return on the portfolio being evaluated at time t, rf the risk-free rate in period t, rm
the return on the market portfolio. βp the sensitivity to the market portfolio.

Example.

Using the following data, measure the performance and rank them according to Jensen’s
Performance Index.

Unit Trust Exp. Return Beta

ASN 10 1.2
ASB 11.5 0.9
ASW 12 0.75
ASD 10.5 0.8

Other information: T-Bill rate = 6%

Return on market = 12%

rp - rf = αp + βp ( rm - rf )

αp = rp - [rf + βp ( rm - rf )]

αp (ASN) = 10 - [6 + 1.2 ( 12 - 6 )] = -3.2

αp (ASB) = 11.5 - [6 + 0.9 ( 12 - 6 )] = 0.1

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αp (ASW) = 12 - [6 + 0.75 ( 12 - 6 )] = 1.68

αp (ASD) = 10.5 - [6 + 0.8 ( 12 - 6 )] = -0.3

Ranking : 1. ASW 2. ASB 3. ASD 4. ASN

Activity

Use the following information.

Portfolio Return Beta Std. Deviation

A 12 1.2 14
B 14 1.4 10
C 16 1.5 12
D 10 0.8 8
E 20 1.8 15
Market Index 12 1.0 12
T-Bill 7 - -

Rank the portfolio according to;

i. Treynor's Performance Index

ii. Sharpe's Performance Index
iii. Jensen's Performance Index

i) Treynor's Performance Index

Tp (A) = (12 – 7)/1.2 = 4.17

Tp (B) = (14 – 7)/1.4 = 5

Tp (C) = (16 – 7)/1.5 = 6

Tp (D) = (10 – 7)/0.8 = 3.75

Tp (E) = (20 – 7)/1.8 = 7.2

Tp (Mkt) = (12 – 7)/1.0 = 5

ii) Sharpe's Performance Index

Sp (A) = (12 – 7)/14 = 0.36

Sp (B) = (14 – 7)/10 = 0.7

Sp (C) = (16 – 7)/12 = 0.75

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Sp (D) = (10 – 7)/8 = 0.375

Sp (E) = (20 – 7)/15 = 0.87

Sp (Mkt) = (12 – 7)/12 = 0.42

iii) Jensen's Performance Index

αp (A) = 12 - [7 + 1.2 ( 12 - 7)] = -1

αp (B) = 14 - [7 + 1.4 ( 12 - 7 )] = 0

αp (C) = 16 - [7 + 1.5 ( 12 - 7 )] = 1.5

αp (D) = 10 - [7 + 0.8 ( 12 - 7 )] = -1

αp (E) = 20 - [7 + 1.8 ( 12 - 7 )] = 4

αp (Mkt) = 12 - [7 + 1.0 ( 12 - 7 )] = 0

Ranking
Rank Sharpe Treynor Jensen
1 E E E
2 C C C
3 B B B
4 Mkt Mkt Mkt
5 D A A
6 A D D

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Checklist
Now are you able to:

Evaluate portfolio performance using Treynor's measure

Evaluate portfolio perfomance using Sharpe's Measure

Differentiate between Treynor and Sharpe portfolio performance measures.

Describe how Jensen portfolio performance measure relate to the Treynor measure

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Study Questions

The following portfolios are being considered for investment. During the period under
consideration, risk free rate is 8%.

Portfolio Expected Return Beta Standard Deviation

Alpine 15 1.0 5
Spritzer 18 1.5 10
Cactus 12 0.8 3
Seamaster 17 1.2 6
Market 13 1.0 4

a). Compute the Sharpe measure of each portfolio and the market
b). Compute the Treynor measure of each portfolio and the market
c). Compute the Jensen measure of each portfolio and the market
d). Rank and comment on the differences and similarities in the ranking.

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