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MIS 4500 (31)

Evaluating Portfolio Performance.docx

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University of Manitoba
Management Info. Systems
MIS 4500
Pourang Irani

Reading 46: Evaluating Portfolio Performance Fund Sponsor’s Perspective: enhances effectiveness of fund’s investment policy by acting as feedback and control mechanism Investment Manager’s Perspective: feedback and control loop, helping to monitor proficiency of various aspects of portfolio construction process 3 components of performance evaluation: 1. account’s performance? (performance measurement) 2. why did account produce observed performance? (performance attribution) 3. luck or skill? (performance appraisal) Performance Measurement:  w/o intraperiod external cash flows MV 1 MV 0 o rt MV 0 MV  MV  CF  o cash flow at start of period: rt 1 0 MV 0 CF MV  CF  MV o cash flow at end of period: t  1 0 MV 0  Total Rate of Return: measures increase in investor’s wealth due to both investment income and capital gains  Time-Weighted Rate of Return (TWR): compound rate of growth over stated evaluation period of one unit of money initially invested in the account; requires account be valued every time external CF occurs o chain linking: create wealth relative by adding return to 1; multiply all wealth relatives for cumulative wealth relative; subtract one; or take to time period power to weight by time o requires valuation on each date of CF  Money-Weighted Rate of Return (MWR): the IRR o MV  MV 1 R m CF 1 R mL(1...CF 1 R mL(n) 1 0 1 n  Linked Internal Rate of Return: take MWR of frequent periods and chain-link those  (account valuations should be reported on trade-date, fully accrued basis: that is stated value of account should reflect impact of unsettled trades and any income owed by or to the account but not yet paid) Benchmarks:  P = M + S + A: portfolio performance is equal to market return plus style return (together the benchmark return) plus the active management return  Properties of Value Benchmark: o unambiguous o investable o measurable o appropriate o reflective of current investment opinions o specified in advance o owned  Types of Benchmarks: o absolute: say a return objective; not investable and not really valid benchmark o manager universes: median manager or fund from broad universe; measurable, but not otherwise valid benchmark  critique of median manager benchmark: not investable, is ambiguous, can’t verify appropriateness, subject to survivor bias o Broad market indexes: say S&P 500; may not reflect style
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