PORTFOLIO EVALUATION

TOOLS IN INSURANCE

 Portfolios contain groups of securities that are selected

to achieve the highest return for a given level of risk.
How well this is achieved depends on how well the
portfolio manager or investor is able to forecast
economic conditions and the future prospects of
companies, and to accurately assess the risk of each
security under consideration.
Many investors and some portfolio managers adopt a
passive portfolio management strategy by simply
holding a basket of securities that is weighted to reflect
a market index, or by buying securities based on a
market index, such as most exchange traded funds.
Some investors and portfolio managers think they can
do better than the market, and so engage in active
portfolio management, buying and selling securities
as conditions change.

Investment Considerations for Portfolio

Decisions
Investment Objective

Capital Preservation
Moderate
Moderate Growth
Growth
Aggressive Growth

Time Horizon
Short term
Long term

Income desired
Income withdrawal
Fund generation

Risk Tolerance
Risk tolerance questionnaire
Risk tolerance profile preparation through score

Measuring Portfolio Returns

Portfolio returns come in the form of current
income and capital gains.
Current income includes dividends on stocks and
interest payments on bonds.
A capital gain or capital loss results when a
security is sold, and is equal to the amount of the
sale price minus the purchase price.

Portfolio Evaluation Tools

There are several Portfolio evaluation tools for
comparing portfolio returns with each other and
with the market in general.
There are 3 common tools that measure a
portfolios risk return tradeoff:
1. Sharpes ratio
2. Treynors ratio
3. Jensens Alpha.

 The Sharpes ratio (or Sharpe's measure), developed

by William F. Sharpe, is the ratio of a portfolios total
return minus the risk free rate divided by the standard
deviation of the portfolio, which is a measure of its risk.
Sharpe Ratio = Risk Premium / Standard Deviation of
Portfolio
Where Risk Premium = Total Portfolio Return Riskfree Rate

Higher the Sharpe ratio, better the performance and the

greater the profits for taking on additional risk
For Example Portfolio return percentage- 10, risk free
rate-4, standard deviation-8
Sharpes Ratio= 10-4/8
= 75%

 Treynors ratio, popularized by Jack L. Treynor,

compares the portfolio risk premium to the
systematic risk of the portfolio as measured by its
beta.
Treynor Ratio = Risk Premium / Portfolio Beta
Where Risk Premium = Total Portfolio Return Riskfree Rate

Note that since the beta of the general market is

defined to be 1, the Treynor Ratio of the market
would be equal to its return minus the risk free rate.
For Example Portfolio return percentage- 10, risk
free rate-4, Beta-1.2
Treynor Ratio = 10-4/1.2
= 5 times

 Jensens alpha (or Jensens index), developed by

Michael C. Jensen, uses the excess return of a
portfolio over its required return, or its expected
return, for its expected risk as measured by its
beta.
Jensens Alpha = Total Portfolio Return RiskFree Rate
[Portfolio Beta (Market Return RiskFree Rate)]
Higher alphas are more desirable.

Example: Portfolio return = 12%, market return

rate = 8%, beta = 1.4, risk free rate = 2%
Jensen's alpha = 12 2 1.4 ( 8 2 ) = 10 1.4 6 = 10
8.4 = 1.6 times

RISK ADJUSTED PERFORMANCE

MEASURES
Risk adjusted performance measures compare the
return on capital to the risk taken to earn this
return i.e. some kind of risk-adjustment is adopted
It is measured either by absolute returns or by
relative returns
Such measures are important as Investors need an
effective tool to evaluate the respective performance
of the various funds compared to the risk taken by
the fund managers to choose the right option for
capital allocation

 Risk-adjusted performance measures are

gradually replacing traditional performance
measures like Return on Equity (ROE) or Return
on Investment (ROI) when it comes to analyzing
performance in financial contexts as these
traditional measures do not take into account
risk.
It helps the management of financial institutions
to evaluate the risk-adjusted performance of their
business units, traders or investment portfolios.

 Performance Measures based on Volatility

Sharpe Ratio
Adjusted Sharpe Ratio

Performance Measures based on Value-at-Risk

Excess Return on Value-at-Risk
Conditional Sharpe Ratio
Modified Sharpe Ratio

Performance Measures based on Lower Partial

Moments

Omega
Sortino Ratio
Kappa 3
Gain-Loss Ratio and Upside-Potential Ratio
Farinelli-Tibiletti Ratio

Performance Measures based on Drawdown

Calmar Ratio
Sterling Ratio
Burke Ratio

Performance Measures based on Valueat-Risk

Excess Return on Value-at-Risk: VaR measures the

worst expected loss over a given time horizon with a
certain confidence level (95%).

Conditional Sharpe Ratio: Overcome the

shortcoming of VaR, which does not consider losses
outside of the confidence interval. Tries to limit the
losses in 100% cases.
Modified Sharpe Ratio: Improvement over above two
methods. Adjust skewness and kurtosis of distribution
related to data collected in above mentioned ratio
calculation through empirical information.