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Measuring Strengths, and Weaknesses in Managing a Portfolio

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In a table, briefly summarize and compare what Sharp, Treynor and Jensen measures, their strengths, weaknesses, and how would you personally utilize and monitor them for a portfolio you are responsible for managing.

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Solution Summary

The solution briefly summarizes and compares what Sharp, Treynor and Jensen measures, their strengths, weaknesses, and how would you personally utilize and monitor them for a portfolio you are responsible for managing.

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Comparison table for Sharp, Treynor and Jensen's measure
Portfolio performance measures Advantages Disadvantages
Sharpe Ratio Easy to calculate (i) Overstates if the historical prices used
(ii) It is overstated if the return are smoothen
(iii) It can be manipulated by the fund managers if non-linear derivatives are used
Treynor Ratio (i) Easy to calculate
(ii) It is a control for market risk exposure (i) It can be overstated if market neutral strategies are used
(ii) In can be overstated if the asset used in portfolio have recently leveraged
(iii) Its not a proper measure for undiversified portfolios.
Jensen's Alpha (i) Easy to calculate
(ii) It rewards the stock selection ability of fund manager (i) It doesn't consider the advantages of a diversified portfolio.
(ii) It also doesn't consider the positive skewness in the portfolio

Sharpe Ratio
Sharpe ratio was derived in 1966 by William Sharpe. This ratio has been one of the most referenced risk/return measures used to measure the performance of any portfolio. Apart from this it is widely used and much popular mainly because of its simplicity. This risk/return measurement technique became more popular and credible when Professor Sharpe won a Nobel Memorial Prize in Economic Sciences in the year 1990 for his work on the capital asset pricing model (CAPM).
As said in above paragraph the Sharpe ratio is simple and this is the reason it is popular. If we look at its formula we can find that it is broken down into just three components (i) asset return, (ii) risk-free return and (iii) standard deviation of return. The formula is:
(see attachment)
Where,
Rp=Return on portfolio
Rf=Risk free rate of return and
σ=standard deviation of portfolio return
Here the excess return also known as risk premium is calculated after subtracting the risk free return from the portfolio return and after calculating the excess return, it's divided by the standard deviation of the risky asset to get its Sharpe ratio. This ratio helps to find out that how much additional return an investor is receiving for the additional volatility of holding the risky asset over a risk-free asset. So the ...

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  • Bsc, Madras University
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