Treynor Portfolio Performance Measure
Please expound and write in detail about the 4 different measures of Portfolio Performance:
- Treynor Portfolio Performance Measure
- Sharpe Portfolio Performance Measure
- Jensen Portfolio Performance Measure
- Information Ratio Performance Measure
Treynor Portfolio Performance Measure
Treynor performance measure is the first composite measure of portfolio performance developed for investors based on risk (Bacon 203). The objective of Treynor portfolio performance measure is to identify a measurement that is suitable for all investors regardless of their risk preferences. Treynor focused his portfolio performance measure based on two components, risk associated with fluctuations in the market, and risk associated with changes in individual securities. Treynor’s concept on security market line focuses on the definition of the relationship between market rate returns and portfolio returns. In this theory, the slope of the market line measures the volatility of returns between the market and portfolio using the beta coefficient (Bacon 204). The beta coefficient measures the instability of the portfolio to the market where the risk-return trade-off is better when the slope of the line is greater. The following formula can determine Treynor ratio:
Sharpe Portfolio Performance Measure
Sharpe portfolio performance measure is the measurement of the fulfillment of a security investment based on the aspect of risk (Friend and Blume 567). Sharpe portfolio performance measure is the same to that of Treynor, except the risk identified is measured based on the concept of standard deviation. Sharpe’s concept shows how well investment of a particular return of security can compensate for the risk taken. Investors can determine Sharpe’s ratio can be by measuring the excess return per unit of deviation. The following formula can illustrate Sharpe’s concept:
Therefore, when comparing two securities based on a standard benchmark, the security with the highest Sharpe ratio will provide a better return for the same risk. The return of the investment depends on the accuracy of the data obtained (Friend and Blume 546). The primary challenge for Sharpe ratio is the notion that risk equals volatility and volatility reduce the potential for return. However, this concept is inaccurate because the more an investor reduces volatility, the less likely to gain higher yields.
Jensen Portfolio Performance Measure
Jensen portfolio performance measure is a measure of excess return that a portfolio generates over the portfolio’s expected return based on the concept of capital asset pricing model (CAPM) (Jonas 821). Michael Jensen first introduced Jensen portfolio performance measure as a measure of the mutual funds in 1968. The Jensen measure relies on the concept that riskier asset should have higher returns than a less risky asset. According to the idea of Jensen portfolio performance measurement, if a security or an asset has a higher yield than its risk-adjusted then the security or asset has an abnormal return. In finance, investors are more attracted towards securities that have higher alpha. Mutual funds managers in the evaluation of mutual funds and portfolio manager performance are still using Jensen Alpha concept (Jonas 826).
In an organization, Jensen alpha is used to measure how much of the portfolio’s rate of return can associate with the ability of the manager to deliver high returns with the adjusted market risk (Jonas 826). Jensen, alpha portfolio performance measure be calculated using the following formula;
The higher the Jensen alpha ratio, the better the risk-adjusted return. Therefore, a portfolio with a consistent positive alpha has a higher return than a portfolio with a negative alpha.
Information Ratio Performance Measure
Information ratio is a performance measurement of a portfolio by how much return an investor can get from the investment of a particular security about the risk the investor has taken. Information ratio can be used to measure the performance of investment managers in areas such as mutual funds and hedge funds (Friend and Blume 550). In this case, information ratio measures aspect such as performance consistency, repeatability, a record of accomplishment and adjustment for risk from the managers in mutual funds and hedge funds. Information ratio tends to focus more on the performance of the managers based on their consistency over a period. Due to this, information ratio can be used to justify whether a manager is active in his or her role in an organization (Friend and Blume 550). In information ratio, the higher the ratio, the better the returns for an investor and if the ratio is below zero, the manager is less active in performing their task in the organization. The following formula can determine information ratio:
Tracking error (standard deviation) = returns of the portfolio – returns of the index
Despite the objective of information ratio in the measurement of the ability of the manager to generate excess returns about the benchmark, this ratio also focuses on identifying if the investor is also consistent with his or her investment (Friend and Blume 575).
Bacon, Carl R. Practical Portfolio Performance Measurement, and Attribution. New York: John Wiley & Sons, (2011): 201-211.
Friend, Irwin and Marshall Blume. “Measurement of Portfolio Performance Under Uncertainty .” The American Economic Review (2010): 521-575.
Jonas, Daniel. “Empowering project portfolio managers: How management involvement impacts project portfolio management performance.” International Journal of Project Management (2010): 818–831.