FINM2003 Study Guide - Final Guide: Survivorship Bias, Passive Management, Sharpe Ratio
Appropriateness of Risk-Adjusted Measures
-Sharpe ratio is appropriate if an investor’s preferences can be summarised by a
mean-variance utility function. If the portfolio represents the entire investment, use S-
ratio, and compare with the best possible alternative passive investment
-Information Ratio
oMeasure for active portfolio
oWhen the investment is an active portfolio to be mixed optimally with a
passive market-index portfolio
-Treynor’s measure: use it when the portfolio whose performance is being evaluated
forms part of a large investment portfolio, consider its systematic risk.
Problems when evaluating performance
1. Statistical inferences problems, need many observations to draw significant
conclusions
2. Distribution of portfolio returns has the potential to change – reasonable to assume the
mean and variance of returns stemming from passive management strategies are
constant over short return intervals but, this assumption is risky for active strategies,
as manages deliberately change the composition of their portfolios based on ongoing
analysis.
3. Survivorship bias: where underperforming funds will tend to be closed down,
leaving only more successful ones to be evaluated or serve as performance
benchmarks
These problems can be minimised by maximising the frequency at which returns are
calculated , more accurate risk parameter estimates by specifying the exact composition of
the portfolio under consideration , and make adjustments to account for bias
Market Timing
- Manager trying to predict future market movements and shifting funds from the
market portfolio to a safer asset when the latter is expected to outperform the former
- Often partial shifts and not fully shifted
Accounting for partial shifts
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Document Summary
Sharpe ratio is appropriate if an investor"s preferences can be summarised by a mean-variance utility function. If the portfolio represents the entire investment, use s- ratio, and compare with the best possible alternative passive investment. Information ratio: measure for active portfolio, when the investment is an active portfolio to be mixed optimally with a passive market-index portfolio. Treynor"s measure: use it when the portfolio whose performance is being evaluated forms part of a large investment portfolio, consider its systematic risk. These problems can be minimised by maximising the frequency at which returns are calculated , more accurate risk parameter estimates by specifying the exact composition of the portfolio under consideration , and make adjustments to account for bias. Manager trying to predict future market movements and shifting funds from the market portfolio to a safer asset when the latter is expected to outperform the former. Often partial shifts and not fully shifted.
