1. AF4 Module 4 Performance Review
03/02/2018
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2. 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
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3. 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?
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4. 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
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5. 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%
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6. 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(CV –OV) + withdrawn money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Number of months the withdrawn money wasn’t invested
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7. 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 £12,000 withdrawn September 1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%
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8. Time Weighted Return (TWR)
Period 2
£20,000 added Total £70,000 Ended £72,000
Period 1
Start £45,000 end £50,000
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9. 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 = 1.141
Deduct 1 to get 0.141
Multiply by 100 to get a TWR of 14.1%
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10. 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
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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
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Performance Measures
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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?
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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%
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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
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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
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18. 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
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19. 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
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20. 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%
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21. 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%
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22. 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%
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23. 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%
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Risk Adjusted Returns
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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
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26. 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
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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
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