Audley Financial Training AF4 Performance Review 2/3/2019 Audley Financial Training

Audley Financial Training How well did we do? Absolute returns Holding Period Return Money weighted Return Time weighted Return Relative returns Alpha Benchmarking Risk related returns` Sharpe ratio Information ratio 2/3/2019 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 2/3/2019 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 2/3/2019 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 + (£10,000 x 7/12) £2,500 £15,833 = 15.78% 2/3/2019 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weighted return: money out Aims to take away the distortions created by adding new money or taking money out (CV –OV) + withdrawn money OV - (withdrawn money x n/12) Number of months the withdrawn money wasn’t invested 2/3/2019 Audley Financial Training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 £12,000 withdrawn September 1 Value December 31 £40,000 (£40,000 - £50,000) + £12,000 £50,000 - (£12,000 x 4/12) £2,000 £46,000 = 4.34% 2/3/2019 Audley Financial Training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 2/3/2019 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% 2/3/2019 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 2/3/2019 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 HPR simple and is accurate if no new money is introduced (or withdrawn) MWR gives an accurate figure if new money is introduced or withdrawn but is misleading if used to compare the performance of two managers TWR is used to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 2/3/2019 Audley Financial Training

Relative performance measures HPR, MWR and TWR are absolute measures. They record how the manager performed But not how well they performed A negative return of 5% might be very good if the overall market return was minus 10% 2/3/2019 Audley Financial Training

7% Alpha 3% Alpha -4% Alpha Actual return 10% Actual return 3% Return predicted by CAPM 7% Actual return 3% Alpha -4% 2/3/2019 Audley Financial Training

Audley Financial Training Why benchmark? To provide independence and neutrality Assess the performance of the manager Help and agree manage client expectations with regard to the portfolio’s performance 2/3/2019 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 Two components: The percentage of each sector held by the benchmark The chosen index for each sector 2/3/2019 Audley Financial Training

Comparison with an index UK shares FTSE 100/250/all share 2/3/2019 Audley Financial Training

Audley Financial Training 2/3/2019 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. 2/3/2019 Audley Financial Training

Weighting: Sector UK shares: Index FTSE 100 Portfolio Benchmark 40% 40% 30% 50% Portfolio underweight Portfolio Overweight 2/3/2019 Audley Financial Training

Audley Financial Training Benchmark 35% UK equities Portfolio 50% UK equities Both return 7% Benchmark 35% x 7% = 2.45% Portfolio 50% x 7% = 3.5% Benchmark 35% UK equities Portfolio 50% UK equities BM return 4% Portfolio 7% Benchmark 35% x 4% = 1.4% Portfolio 50% x7% = 3.5% Benchmark 35% x 7% = 2.45% Portfolio 50% x 4% = 2% Benchmark 35% UK equities Portfolio 50% UK equities BM return 7% Portfolio 4% Benchmark 50% x 7% = 3.5% Portfolio 35% x 4% = 1.4% 2/3/2019 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% 2/3/2019 Audley Financial Training

Performance due to asset allocation P/F allocation BM return Contribution 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% 2/3/2019 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% 2/3/2019 Audley Financial Training

Sharpe ratio Three inputs: Portfolio return Risk free return Standard Deviation of portfolio Measures performance adjusted for risk Formula Portfolio return less RF SD 2/3/2019 Audley Financial Training

Audley Financial Training Sharpe ratio 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 2/3/2019 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 2/3/2019 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 2/3/2019 Audley Financial Training

AF4 Day 2 objectives By the end of the event delegates will be able to:   Identify the factors that must be considered in recommending an appropriate portfolio for a client’s needs Understand the characteristics of the main investment strategies. Understand the characteristics of “non-main stream” investments such as options, CFDs and Hedge Funds. Accurately calculate the Holding Period Return, Money Weighted Period Return, Time Weighted Period Return and identify when it would be appropriate to use each. Understand the concept of Alpha. Accurately calculate and interpret the main risk related returns, Sharp Ratio and Information Ratio Understand the concept of benchmarking. Analyse the performance of a portfolio and identify the cause of under or over performance. 2/3/2019 Audley Financial Training