Zeus Asset Management

Business and Economics

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Business and Economics

Funds Management Performance

(BKM Ch 24)

Introduction
§ Investment Performance is a complicated subject § Theoretically correct measures are difficult to construct § Different statistics or measures are appropriate for different types of investment decisions or portfolios § Many industry and academic measures are different § The nature of active management leads to measurement problems

Introduction
§ Two common ways to measure average portfolio return:

1. Time-weighted returns 2. Dollar-weighted returns
§ Returns must be adjusted for risk.

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Dollar- and Time-Weighted Returns
Time-weighted returns § The geometric average is a time-weighted average. § Each period’s return has equal weight.

(1 + rG ) = (1 + r1 )(1 + r2 )...(1 + rn )
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n

Dollar- and Time-Weighted Returns
Dollar-weighted returns
§ Internal rate of return considering the cash flow from or to investment § Returns are weighted by the amount invested in each period:

Cn C1 C2 PV = + + ... 1 2 (1 + r ) (1 + r ) (1 + r )n

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Example of Multiperiod Returns

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Dollar-Weighted Return
$2 $4+$108

-

$50

-

$53

Dollar-weighted Return (IRR):

− 51 112 − 50 = + 1 (1 + r ) (1 + r ) 2 r = 7.117%
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Time-Weighted Return
53 − 50 + 2 r1 = = 10% 50 54 − 53 + 2 r2 = = 5.66% 53 rG = [ (1.1) (1.0566) ]1/2 – 1 = 7.81% The dollar-weighted average is less than the time-weighted average in this example because more money is invested in year two, when the return was lower.
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Adjusting Returns for Risk
§ The simplest and most popular way to adjust returns for risk is to compare the portfolio’s return with the returns on a comparison universe. § The