Question

One of the most important, if not the most important aspect of portfolio analysis is that of “Performance Evaluation”, therefore it is very important that investments practitioners utilize the different methods of performance evaluation to understand the results which were generated. Do you agree or disagree, provide detailed information to support.

Answer 1

• Yes we must agree to the statement " One of the most important, if not the most important aspect of portfolio analysis is that of “Performance Evaluation”, therefore it is very important that investments practitioners utilize the different methods of performance evaluation to understand the results which were generated." this is because investors success is not only determined by the returns, there is also involvement of risk aswell. We must quantify risk and return together and evaluate a porfolio and this helps in understand the exact performance of the portfolio. Today's Investors usually use three performance measurement tool to evalulate the actual performance of a portfolio.
• The Treynor, Sharpe, and Jensen ratios combine risk and return performance into a single value, but each are slightly different from one another. Sometimes the combination of all three is used to evaluate the performance of a portfolio.
• Stock markets are very volatile and always has exposures to many market risks, thus to evaluate the actual performance Jack L. Treynor introduced a measure where an investors will have  a composite measure of portfolio performance including risk. Treynor's objective is to find a performance measure that could apply to all investors regardless of their personal risk preferences. Treynor suggested that there are really two components of risk: the risk produced by fluctuations in the stock market and the risk arising from the fluctuations of individual securities.
• Stock market hence is volatile can be effected by market fluctuation , inflation and other risks , such volatality is denoted by Beta in a market. Other measures  Sharpe ratio is almost identical to the Treynor measure, uses risk measure is the standard deviation of the portfolio instead of considering only the systematic risk as represented by beta. This helps in evalution the performance of a stock or portfolio more accurately and this measure is also known as CAPM or capital asset pricing model.
• Similar to the previous performance measures there is another measure called  the Jensen measure is calculated using the CAPM. Named after its creator, Michael C. Jensen, the Jensen measure calculates the excess return that a portfolio generates over its expected return. This measure of return called or denoted as Alpha.This adjusts the market risk and if a portfolio is has a postitive return then the Alpha is positive and if the return is negative the Alpha is negative.
• So one must agree that return is not the only things a investor must considered before investing , the performance evaluation is a key to understand the actual return one can get from it. Thus performance evaluation helps an investor to know how effectively his or her money is invested in the stock market. Without adusting the risk or evaluating the risk adjsuted returns true picture of a investment can not be understood, so to come to an conslusive decision performance evaluation is one of the most important aspect in portfolio analysis.