1. During the annual review of Aaron’s pension plan, several trustees questioned Lucy Wong, a pension consultant, about various aspects of performance measurement and risk assessment. In particular, one trustee asked about the appropriateness of using each of the following benchmarks: Market index Benchmark normal portfolio Median of the manager universe (a) Explain the different weaknesses of using each of the three benchmarks to measure the performance of a portfolio. (10 marks) Another trustee asked how to distinguish among the following performance measures: The Sharpe ratio The Treynor measure Jensen’s alpha Answer: Benchmarking is a method of measuring performance against a standard, or given set of standards. – Gives us a reference point for comparison – Comparison of return and risk Assignment 2 –Portfolio construction and risk management Do Thi Hai Ha Page 3 A useful way to characterize benchmarks is whether they are synthetic, or application ("real world") based. A synthetic benchmark is created with the intent to measure one or more features of a system, processor, or compiler. Synthetic benchmarks may try to mimic instruction mixes in real world applications, or they may be artificial. Synthetic benchmarks are useful in debugging specific features, but they cannot be easily related to how that feature will perform in an application. Because they are useful in debugging or isolating specific functionality, synthetic benchmarks tend to be small, though this is not a requirement. More over, each benchmark has its different weaknesses in using to measure the performance of performance of portfolio because different risk adjustment measures can give different implications about a portfolio’s performance, it is important that we choose the appropriate measuring tool for our particular portfolio. If we are only evaluating a portion of our portfolio, most recommend that we use the Jensen or the Treynor measure. If the portfolio comprises many different assets and asset classes, If our portfolio is well diversified, our main concern will generally be non-diversifiable risk (the risk you cannot diversify away through owning more assets). Of these two measures, the Treynor measure is more complete because it adjusts for non-diversifiable risk. (Ibid). There are limitations to the usefulness of risk-adjustment measures. The assumptions that underlie these measures limit their usefulness. It is important for us to understand these assumptions. For example, these measures assume that a portfolio is basically stable: however, when the portfolio is being actively managed, basic stability requirements for some statistical measures are not met. Risk-adjustment measures should be used with caution. In addition to using risk-adjustment measures, investors should measure performance by comparing their portfolios with portfolio benchmarks as well as comparing their portfolios with the portfolios of other investors in the same investment-objective category. [charge=450]http://up.4share.vn/f/2c1d15181b1d1c1b/Assignment 2-Final.pdf[/charge]
