Portfolio Performance

Table of Contents

1. Introduction 2

2. Portfolio Returns Calculation 4

2.1. Time weighted rate of return 5

2.2. Value weighted rate of return 6

2.3. Internal rate of return 6

3. Literature Review 7

3.1. Sharpe ratio 9

3.2. Sortino ratio 10

3.3. Treynor ratio 12

3.4. Jensen ratio 13

Weaknesses of traditional performance measures 15

Conclusion 18

Bibliography 20

Introduction

In this paper, we conduct an in-depth literature review on the topic “portfolio performance evaluation”. A portfolio is a collection of different investments, which is owned by an individual or an institution on which an investor bets to make a profit without compromising the principal investment. A portfolio can include assets such as real estate and gold; however, most investment portfolios are made up on securities such as stocks, bonds, mutual funds, exchange traded funds and cash. Portfolio evaluation refers to assessing the performance of an investment portfolio. It is a process of comparing the returns earned on one portfolio with the returns earned on another investment portfolio by measuring and evaluating the performance. Performance measurement measures the returns earned and performance evaluation discloses additional issues such as out-performance or under-performance of the investment and the reasons behind such performance i.e. due to investment managers’ skills, market, economic, political circumstances or sheer luck. It is all about differentiating those investment managers who truly add value through active management from those who do not. (Lehmann & Timmermann, 2007)

In the 1950s performance of a portfolio was measured only based on returns earned. Although investment managers realized that risk was a crucial element to consider while measuring the performance, there was no easy approach to factor that in. Subsequent to this period, Harry Max Markowitz, an American economist conceptualized a Modern Portfolio Theory (MPT). The theory provides a framework to construct and select portfolios based on the expected performance of the investment and the risk appetite of the investor. (Fabozzi, Gupta, & Markowitz, 2002) In later years many more financially sophisticated tools and concepts were established to assess the performance of a portfolio allowing investment