Contemporary Investments: Chapter 21 Chapter 21 EVALUATING INVESTMENT PERFORMANCE What issues are important when evaluating investment performance? How are risk and return measured? What are three measures of risk- adjusted performance? How good is past performance as a predictor of future performance?

Contemporary Investments: Chapter 21 Performance evaluation issues AIMR guidelines Time periods Appropriate benchmarks Risk Objectives and constraints

Contemporary Investments: Chapter 21 Measuring risk and return Return –Holding period return –Total return index –Measures of average returns Arithmetic mean Geometric mean

Contemporary Investments: Chapter 21 Measuring risk and return – Cont. Risk –Standard deviation –Beta –R-square Risk and return measures of the Legg- Mason Value Trust –Average returns –Risk measures

Contemporary Investments: Chapter 21 Figure 21.1 – Cumulative Wealth Indexes for the Legg-Mason Value Trust and the S&P500

Contemporary Investments: Chapter 21 Assessing risk-adjusted performance Treynor performance measure –How calculated –Relationship to CAPM and the security market line –Examples Legg-Mason Value Trust S&P 500

Contemporary Investments: Chapter 21 Figure 21.2 – Interpreting the Treynor Measure

Contemporary Investments: Chapter 21 Assessing risk-adjusted performance- Cont. Sharpe performance measure –How calculated –Relationship to the capital market line –Examples Legg-Mason Value Trust S&P 500 Differences between Treynor and Sharpe measures

Contemporary Investments: Chapter 21 Figure 21.3 – Interpreting the Sharpe Measure

Contemporary Investments: Chapter 21 Assessing risk-adjusted performance-Cont. Jensen’s alpha –How calculated –Relationship to CAPM and security market line –Examples Legg-Mason Value Trust S&P 500 Comparing Treynor, Sharpe, and Jensen

Contemporary Investments: Chapter 21 Figure 21.4 – Interpreting Jensen’s Alpha

Contemporary Investments: Chapter 21 Past and future performance Does the past predict the future? –Yes and No! –Fund performance revert to mean –But top fund managers tend to outperform the worst fund managers