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Performance Evaluation

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Strategic and Tactical Asset Allocation

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Abstract

In this chapter, we address the following questions. Which benchmark should be used to assess the performance of active managers? How can we measure the risk-adjusted performance of portfolio managers? Finally, how do we measure how an active manager achieved a given return?

“There are 3 types of accountant—those that can count and those that can’t.”

—Anon

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Notes

  1. 1.

    See, for example, Bailey et al. (1990), Bailey (1992) and Bailey et al. (2007).

  2. 2.

    Meaning that they offer the highest expected return for any level of risk. See further the Appendix to the book.

  3. 3.

    See further http://us.spindices.com/indices/equity/sp-500

  4. 4.

    Robert Arnott’s riposte to this has been that while this would apply if the entire investment universe switched to fundamentally based indices, vast sums of money would have to move in that direction first. See further Arnott (2006).

  5. 5.

    This subject will be covered in depth in Chaps. 6 and 7.

  6. 6.

    Soe and Dash (2009) and Brzenk and Soe (2015) estimate that approximately half of the excess return of the S&P 600 over the Russell 2000 is due to recomposition effects of the Russell 2000 (“July Effect”), as outperforming small-caps are promoted to the Russell 1000 from the Russell 2000, while under-performing stocks are moved from the Russell 1000 to the Russell 2000. Chen et al. (2006) examines the impact of changes in index compositions for investors.

  7. 7.

    See also Kritzman (1987), Christopherson (1998), Kuenzi (2008) and Lo (2016).

  8. 8.

    Sharpe suggests using quadratic programming to determine the exposure of a portfolio to different investment styles (or asset classes), represented by indices such as the one discussed previously. See further Sharpe (1988, 1992).

  9. 9.

    All of this is related to the question of active risk vs. policy risk which we will discuss in the following chapter.

  10. 10.

    The review is not exhaustive. For a more extensive coverage, see, for example, Amene and Lesourd (2003) or Feibel (2003).

  11. 11.

    The Appendix to the book gives a brief review of the CAPM.

  12. 12.

    See Roll (1978).

  13. 13.

    Implicitly, the risk-free rate is the benchmark in the SR.

  14. 14.

    We will return to this question in our discussion in Chap. 5.

  15. 15.

    See also Treynor and Black (1973) and Sharpe (1994).

  16. 16.

    We will look at this in greater depth in Chap. 9.

  17. 17.

    More on this in Chap. 9.

  18. 18.

    See also, for example, Feibel (2003) and Amene and Lesourd (2003).

  19. 19.

    Strictly speaking, we should refer to the outperformance as percentage points rather than %. Our manager has delivered an outperformance of 2.3% measured on the basis of the initial capital invested. But she has only outperformed the benchmark by ((1.18/1.157)−1) × 100 = 1.989%. We’ll use % in the following for ease of exposition.

  20. 20.

    As far as she is concerned, \( {r}_i^p \) is an unbiased estimator of \( {r}_i^b. \)

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Authors and Affiliations

  1. Instituto de Empresa Business School, Madrid, Spain

    Henrik Lumholdt

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  1. Henrik Lumholdt
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Lumholdt, H. (2018). Performance Evaluation. In: Strategic and Tactical Asset Allocation. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-89554-3_2

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  • DOI: https://doi.org/10.1007/978-3-319-89554-3_2

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