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Unit 13: Portfolio Performance Evaluation




                            Return due to risk = (R  – R  – (Return due to selectivity)         Notes
                                               A   F
                                            (8% – 2%) – (1.31%)
                                            4.69 or – 4.7%
                            Total excess return = Selectivity + Risk

                                    (R  – R ) = [R  – R( )] + [R( ) – R ]
                                      A   F    A    A       A   F
                                 [8.0% – 2.0%] = [8.0% – 6.7%] + [6.7% – 2.0%]
                                         6% = 1.3% + 4.7%




              Task       Suppose you are asked to analyse two portfolios having the following
                         characteristics:
                               Observed Return        Beta        Residual Variance

              Portfolio I Gate      0.18              2.0               0.03
              Portfolio Wipro       0.12              1.5               0.00

             The risk-free rate is 0.07. The return on the market portfolio is 0.15. The standard deviation
             of the market is 0.06.
             1.  Compute the Jensen index for portfolio I-Gate and Wipro.
             2.  Compute the Sharpe index for the market portfolio.

             3.  Compute the Sharpe index for portfolios I-Gate and Wipro
             4.  Compute the Treynor index for the portfolios I-Gate and Wipro

          13.2 Determinants of Portfolio Performance

          Performance of the portfolio depends on certain critical decisions taken by a portfolio manager.
          An evaluation of these decisions helps us to determine the  activities that need efficiency for
          better portfolio performance. The popular activities associated in this regard are:
          1.   Investment policy

          2.   Stock Selection
          3.   Market  Timing
          The risk-adjusted performance measures discussed earlier primarily provide an analysis on the
          overall performance of a portfolio without breaking it up into sources or components. Eugene
          Fama has given a framework towards this purpose. Let us see it now.
          As we know that Security Market Line (SML) is likely to provide a relationship between the
          systematic risk (B) and return on an Asset, Fama used this framework to break the actual realised
          return into two parts. A part of the return may be due to the size of risk that the asset carries and
          the remaining due to the superior selectivity skills of the portfolio manager. The excess return-
          form of SML can be used to estimate the expected returns. If actual return is more or less than
          such expected  returns, it can be attributed to superior or inferior stock selection. Then, total
          excess return on a portfolio (say A) = Selectivity + Risk






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