Evaluation of Portfolio

Evaluation of Portfolio

 Evaluation of portfolio means to evaluate

the alternative portfolio’s in order to find
out and select the best-suited one.
 Actually a well-managed portfolio is called
generally as a Mutual Fund.
 Trading Schemes of Mutual Funds
 Close Ended Scheme
 Fixed time period within which an investor has to invest / sell.
 The sale/ purchase will be for a specified numbers of mutual fund units.
 In this scheme the mutual fund units are listed in a recognized stock
exchange. So, during trading interference of the stock exchange always
exits.
 The price offered for mutual fund units may be at premium or discount.

Open Ended Scheme

 No fixed period for trading.
 Units can be sold / purchased continuously without any restriction to the
number of mutual fund units.
 Units can be purchased / sold directly without the intervention of the
stock exchange i.e. just by applying to the funds manager.
 Here the price of each unit of mutual fund is based on the net asset
value of a particular scheme i.e. on the basis of the values of the
securities contained in that mutual fund unit.
 Load Factor in Mutual Fund
Load Factor is the commission charges paid by
the investor at the time of sell / purchase of the
mutual fund units. There are two types of Load
factor.

Front End Load Factor – In this case the

commission charged is deducted from the total
amount invested. So it reduces the number of
mutual fund units purchased.

Back End Load Factor – In this case the sales

proceeds is reduced due to the commission
charged.
 Portfolio Evaluation
 There are three indexes for the evaluation of
portfolio to find out the best well managed
portfolio. These are:
 Sharpes’ Performance Index
 Treynors’ Performance Index
 Jensen Performance Index
 Sharpe’s’ Performance Index

 It is based on the single value to be taken into

consideration for measuring the performance of
portfolios.

 It measures the Risk Premium of the portfolio

(RP) relative to the total amount of risk in that
portfolio (δp).
 Rp = Portfolio average return
Sharpe Index Si = Rp – Rf Rf = Risk free rate of return
δp δp = Standard deviation of
portfolio return i.e. Risk

 Decision: If Si Index is

 Larger – It is a better portfolio to invest.

 Smaller – It is not a better portfolio to

invest.
Treynors Performance Index
 Treynor Index is based on the concept of
Characteristic Regression Line.
 Characteristics Regression Line establishes the
relationship between the portfolio return and the
market return.
 So, in Treynor’s Index of a particular portfolio is
determined in relation to the performance of
market.
 It is concluded from the Characteristics
Regression Line that, an ideal portfolio is that,
where the return of portfolio raises at a faster
than the general market performance.
As per Characteristics Regression Line,
Rp = α + β x Rm + ep
Where, β co-efficient measures the systematic risk.

So Treynor index measures the risk premium of a portfolio

in relation to its systematic risk.

Treynor’s Index Tn = Rp – Rf Rp = Portfolio average

return
p Rf = Risk free rate of return
p = Systematic risk

 Decision: If Tn Index is
 Larger – It means the portfolio earns more risk premium
per unit of systematic risk So it is a better portfolio to
invest..
 Smaller – It is not a better portfolio to invest .
Rank the following funds by using Sharpe and Treynor
Index, where risk free rate of return is 9%

Rp Std. Dev Beta

Blue Chip 25.38 4 0.23
Leading 25.11 9.01 0.56
sector
contra 25.01 3.55 0.59
 Sortino ratio
 It measures how much return deviates from minimal acceptable
rate.
 A large value of sortino ratio points to the low risk of significant
losses occurring.
Sortino ratio  ( r - rr )/ down
Where,
r  average return
rr  minimum acceptable return
 down  downside risk
 down 
 r
d
2

N
Where,
rd  ( ri  rr )  rr
ri  return for the period i
N  Number of period
rr  minimum acceptable return
Upside Potential Ratio is measure of excess return i.e the
investor prefer highest return above the minimum acceptable
return

Upside Potential ratio 

 r u

 down

Upside Potential 
 r u

N
ru  (ri  rr )  rr
 ri Rd= (ri<0.80)-0.8 Rd2 Ru= (ri>0.8)-0.8
4.8 0 0 4
-4.4 -5.2 27.04 0
7.3 0 0 6.5
2 0 0 1.2
5.9 0 0 5.1
-2.6 -3.4 11.56 0
8.4 0 0 7.6
6.9 0 0 6.1
-7 -7.8 60.84 0
3 0 0 2.2
-0.6 -1.4 1.96 0
-1.2 -2 4 0
5 0 0 4.2
4 0 0 3.2
-0.2 -1 1 0
Jensen’s Performance Index
 Jensen‘s performance index is based on
the absolute risk adjusted rate of return
on the basic of the CAPM model but taking
into consideration an additional factor
known as the predicative ability of the
managers for constructing the portfolios.
As per Capital Asset Pricing Model, Return of the Portfolio is:
Rp = Rf+  (Rm – Rf)

So, as per Jensen‘s Performance Index, Return of the

Portfolio is:

Rp =  +  (Rm – Rf) + Rf
Where,  = Manager’s ability to predict future

Jensen‘s Performance Index =  / 

 Decision : Based on ‘’

• If manager’s • If manager’s ability •If manager’s

ability to predict to predict the future ability to predict
the future is better is poor then ‘’ is the future is
then ‘’ is positive. negative. average then
• ‘Rp’ is greater. • ‘ Rp’ is less. ‘’=0.
• So, Better not to
• So, better to invest invest in this •There is no
in this portfolio portfolio. change.

C
Rp-Rf A (Rp-Rf) = Excess Return
B (Rm-Rf) = Risk
Rf
Portfolio C : Rp =  +  (Rm – Rf) + Rf
Portfolio A: Rp =  (Rm – Rf) + Rf
Portfolio B : Rp = - +  (Rm – Rf) + Rf
 (Rm-Rf)
 Rp Std.dev Beta
Balanced 25.38 4 0.23
Fund
Small and 36.28 6.86 0.52
mid cap
Infra fund 45.56 4.31 0.63
Market 36.74 3.69

The risk free rate of return is 9%.

Using the above information, rank the
fund on the basis of Jensen Index.
 M2 Measure
 Developed by Modigliani and Modigliani
 Equates the volatility of the managed
portfolio with the market by creating a
hypothetical portfolio made up of T-bills
and the managed portfolio
 If the risk is lower than the market,
leverage is used and the hypothetical
portfolio is compared to the market
 M2 Measure = Rp – Rm
 Where,
 Rp = Portfolio average return
 Rm = Market return
 M2 Measure: Example
Managed Portfolio Market T-bill
Return 35% 28% 6%
Stan. Dev 42% 30% 0%
Hypothetical Portfolio: Same Risk as Market
30/42 = .714 in P (1-.714) or .286 in T-bills
Rp = (.714) (.35) + (.286) (.06) = 26.7%
Rm = 28%
M2 Measure = Rp – Rm = 26.7% - 28% = -1.3
Since this return is less than the market, the managed portfolio
underperformed
The M2 of Portfolio P