Mutual Fund Evaluation/Model

Ranpreet Kaur

Performance Evaluation of MF

Asset mix NAV Entry and exit load Rate of return Portfolio turnover Expense ratio Beta Standard deviation

Treynor ratio

The Treynor ratio (sometimes called the reward-tovolatility ratio or Treynor measure), named after Jack L. Treynor It is a measurement of the returns earned in excess of that which could have been earned on an investment that has no diversifiable risk, per each unit of market risk assumed. The Treynor ratio relates excess return over the risk-free rate to the additional risk taken; however, systematic risk is used instead of total risk.

Conti.
It is defined asA ratio of return generated by the fund over and above risk free rate of return (generally taken to be the return on securities backed by the government, as there is no credit risk associated), during a given period and systematic risk associated with it (beta). Symbolically, it can be represented as:

Treynor's Index (Ti) = (R-Rf)/

Interpretation
While a high and positive Treynor's Index shows a superior risk-adjusted performance of a fund, a low and negative Treynor's Index is an indication of unfavorable performance. The higher the Treynor ratio, the better the performance of the mutual Fund/portfolio under analysis

Sharpe Model/Ratio

The Sharpe ratio or Sharpe index or Sharpe measure or reward-to-variability ratio is a measure of the excess return (or risk premium) per unit of deviation in an investment asset.

Typically referred to as risk (and is a deviation risk measure), named after William Sharpe.

Sharpe Ratio
According to Sharpe, it is the total risk of the fund that the investors are concerned about. So, the model evaluates funds on the basis of reward per unit of total risk. It is defined as A ratio of returns generated by the fund over and above risk free rate of return and the total risk associated with it. Symbolically, it can be written as: Sharpe Index (Si) = (R - Rf)/6

Interpretation

While a high and positive Sharpe Ratio shows a superior risk-adjusted performance of a fund, a low and negative Sharpe Ratio is an indication of unfavorable performance.

Sharpe measure Treynor measure

R Rf

R Rf

where R average return R f risk-free rate

standard deviation of returns beta

Importance

Indicates the how well the return of an asset compensates the investor for the risk taken, higher the Sharpe ratio number the better. used to rank the performance of portfolio or mutual fund comparing two assets each with the expected return against the same benchmark with return , the asset with the higher Sharpe ratio gives more return for the same risk. It is directly computable from any observed series of returns without need for additional information surrounding the source of profitability.

Difference between Sharpe and Treynor Measures (contd)

The Treynor measure evaluates the return relative to beta, a measure of systematic risk It ignores any unsystematic risk The Sharpe measure evaluates return relative to total risk Appropriate for a well-diversified portfolio, but not for individual securities

Jenson's Model

Jenson's model proposes another risk adjusted performance measure. This measure was developed by Michael Jenson and is sometimes referred to as the Differential Return Method. This measure involves evaluation of the returns that the fund has generated vs. the returns actually expected out of the fund given the level of its systematic risk. The surplus between the two returns is called Alpha, which measures the performance of a fund compared with the actual returns over the period.

Expected/Required return of a fund at a given level of risk (Bi) can be calculated as:

Ri = Rf + Bi (Rm - Rf)
Where, Rm is average market return during the given period. After calculating it, alpha can be obtained by subtracting required return from the actual return of the fund.

InterpretationHigher alpha represents superior performance of the fund and vice versa. LimitationLimitation of this model is that it considers only systematic risk not the entire risk associated with the fund and an ordinary investor can not mitigate unsystematic risk, as his knowledge of market is primitive.