AF4 Module 4 Performance Review 03/02/2018 Audley Financial Training

Performance Review: what you need to know Absolute Returns. Calculation of: Holding Period Return Money Weighted Return Time weighted return Bench marking and performance analysis Alpha Portfolio analysis Risk Related Returns Sharpe Ratio Information ratio 03/02/2018 Audley Financial Training

Audley Financial Training Holding Period Return Bill invested £10,000 on January 1 and received £400 in dividends. The fund had grown to £11,000 on December 31. What return had he made? £11,000 -£10,000 + £400 = 14% £10,000 Suppose he invested £10,000 on June 1 using the same formula and the value on 31 December was £22,500 what would the return be? 03/02/2018 Audley Financial Training

Money weighted return: money in Aims to take away the distortions created by adding new money or taking money out Original Value (CV –OV) - New money OV + (New x n/12) Final Value Number of months the new money was invested 03/02/2018 Audley Financial Training

Audley Financial Training MWR: Money in Original Investment £10,000 January 1. £10,000 added June 1 Value December 31 £22,500 (£22,500 - £10,000) - £10,000 £10,000 + (£12,000 x 7/12) £2,500 £17,000 = 14.7% 03/02/2018 Audley Financial Training

Money weighted return: money out Aims to take away the distortions created by adding new money or taking money out (CV –OV) + withdrawn money OV - (New x n/12) Number of months the withdrawn money wasn’t invested 03/02/2018 Audley Financial Training

Audley Financial Training MWR: Money out Original Investment £50,000 January 1. £12,000 withdrawn September 1 Value December 31 £40,000 (£40,000 - £50,000) + £12,000 £50,000 - (£12,000 x 4/12) £2,000 £46,000 = 4.34% 03/02/2018 Audley Financial Training

Time Weighted Return (TWR) Period 2 £20,000 added Total £70,000 Ended £72,000 Period 1 Start £45,000 end £50,000 03/02/2018 Audley Financial Training

Audley Financial Training The calculation Work out HPR for each period Period 1: £50,000 less £45,000/£45,000 = 0.11 Period 2: £72,000 less £70,000/£70,000 = 0.028 Add 1 to each figure and multiply 1.11 x 1.028 = 1.141 Deduct 1 to get 0.141 Multiply by 100 to get a TWR of 14.1% 03/02/2018 Audley Financial Training

Time Weighted Return summary Calculate the HPR for each separate period Put the answer as a decimal rather than a percentage and add 1 to each answer. Multiply the two together. Subtract 1 from the result and multiply by 100 to get a percentage 03/02/2018 Audley Financial Training

Audley Financial Training Which to use? HPR simple and is accurate if no new money is introduced (or withdrawn) MWR gives an accurate figure if new money is introduced or withdrawn but is misleading if used to compare the performance of two managers TWR is used to compare two managers’ performance as it is not affected by cash flows in and out of the fund 03/02/2018 Audley Financial Training

Audley Financial Training Performance Measures 03/02/2018 Audley Financial Training

Audley Financial Training Performance measures Was it better than what was expected as measured by CAPM? Was it better than an index? Did you do better than another manager? Did you do better than a benchmark? 03/02/2018 Audley Financial Training

Audley Financial Training Alpha Measures the value added by a fund manager CAPM measures the expected return If this is 7% and the actual return is 9.5% the alpha is 2.5% Alpha can be positive or negative Expected return 7% actual return 5%, alpha is -2% 03/02/2018 Audley Financial Training

Audley Financial Training Why benchmark? To provide independence and neutrality Assess the performance of the manager Assess the underlying contribution due to asset allocation and stock selection Help and agree manage client expectations with regard to the portfolio’s performance 03/02/2018 Audley Financial Training

Audley Financial Training Selection criteria Specified in advance Agreed with the client Transparent and unambiguous Appropriate to the client’s objectives in line with their attitude to risk 03/02/2018 Audley Financial Training

Audley Financial Training 03/02/2018 Audley Financial Training

Audley Financial Training Portfolio Analysis At the end of the review period the portfolio will have either under or overperformed its benchmark. This will be as a result of two factors: The portfolio got a better or worse performance than the index in each sector This is compounded by having a different asset allocation to the benchmark. 03/02/2018 Audley Financial Training

Asset Allocation analysis The portfolio chose to have 40% holding in UK shares against the benchmark of 30% holding The manager is said to be overweight in UK shares If the manager had a 20% holding it would be underweight If both achieved the same return being overweight would have a positive outcome and underweight a negative one. If returns are different the effect of different weightings can also be assessed 03/02/2018 Audley Financial Training

Audley Financial Training Performance analysis Benchmark Portfolio Percentage Index Contrib UK 55% 15% Overseas 30% Gilts 10% Percentage Return Contrib UK 40% 20% Overseas 10% Gilts 15% 03/02/2018 Audley Financial Training

Audley Financial Training Performance analysis Benchmark Portfolio Percentage Index Contrib UK 55% 18% 9.9% Overseas 30% 15% 4.5% Gilts 10% 1.5% 15.9% Percentage Return Contrib UK 30% 20% 6% Overseas 50% 10% 5% Gilts 15% 3% 14% 03/02/2018 Audley Financial Training

Performance due to asset allocation P/F allocation Index return Contribution BM return Difference UK 30% 18% 5.4% 9.9% -4.5% Overseas 50% 15% 7.5% 4.5% 3% Gilts 20% 10% 2% 1.5% 0.5% 14.9% 15.9% -1% 03/02/2018 Audley Financial Training

Performance due to Stock Picking Benchmark allocation Portfolio return Contribution BM return Difference UK 55% 20% 11% 9.9% +1.1% Overseas 30% 10% 3% 4.5% -1.5% Gilts 15% 2.25% 1.5% + 0.75% 16.25% 15.9% +0.35% 03/02/2018 Audley Financial Training

Audley Financial Training Risk Adjusted Returns 03/02/2018 Audley Financial Training

Audley Financial Training Sharpe ratio Measures performance compared to the level of risk taken Return less Risk Free/SD of portfolio Portfolio A 15% return, SD 8% Portfolio B 6% return SD 2% Risk Free return 1% A 15-1/8 = 1.75 B 6-1/2 = 2.5 With Sharpe the higher the number the better B has produced the best risk adjusted return 03/02/2018 Audley Financial Training

Audley Financial Training Information ratio Year Portfolio BM Difference 1 5% 3% 2% 2 -2% -4% 3 4 -3% -5% 5 25% 23% 6 8% 0% 7 4% 6% 8 9 10 Average 5.2% 3.6% SD 1.9% Measures the consistency of a manager over a period of time Calculates the difference between the portfolio and the benchmark. Portfolio return – BM return SD of difference 03/02/2018 Audley Financial Training

Audley Financial Training Interpreting IR 5.2% less 3.6% = 0.84 1.9% IR can be positive or negative 0.5 is considered good 0.85 is very good Greater than 1 is excellent 03/02/2018 Audley Financial Training