INVESTMENT AND PORTFOLIO MANAGEMENT CHAPTER 8

INVESTMENT PERFORMANCE

TOPICS:
1. WHAT IS INVESTMENT PERFORMANCE
2. KEY PERFORMANCE METRICS AND RATIOS FOR
INVESTMENT PERFORMANCE
3. BENCHMARKIING AND INVESTMENT PERFORMANCE
EVALUATION
4. FACTORS AFFECTING INVESTMENT PERFORMANCE
5. IMPROVING INVESTMENT PERFORMANCE

● What Is Investment Performance?

Investment performance refers to the return generated by an investment over a specified period. It is a
critical measure of how well an investment is doing and helps investors gauge the success of their
investment decisions.

Measuring investment performance is essential for investors to evaluate the effectiveness of their
investment strategies, compare their investments against benchmarks or peers, and make informed
decisions on portfolio adjustments.

Understanding investment performance also helps identify areas of improvement and optimize
investment returns.

Several factors influence investment performance, including market conditions, economic trends,
investment strategies, portfolio management, and investor behavior.

These factors contribute to an investment's overall success or failure and should be considered when
evaluating investment performance.

● Key Performance Metrics and Ratios for Investment Performance

 Return on Investment (ROI):
Return on Investment (ROI) is a simple performance metric that calculates the percentage
return generated by an investment relative to its initial cost. It is a widely used measure to
evaluate the efficiency and profitability of an investment.

 Compound Annual Growth Rate (CAGR)

Compound Annual Growth Rate (CAGR) is a performance metric that calculates an investment's
average annual growth rate over a specified period.

CAGR smooths out short-term fluctuations and provides a more accurate representation of an
investment's long-term performance.
 Sharpe Ratio

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The Sharpe Ratio is a risk-adjusted performance metric that measures the excess return
generated by an investment per unit of risk taken. A higher Sharpe Ratio indicates a better risk-
adjusted return, helping investors compare investments with different risk levels.

 Information Ratio
The Information Ratio measures the excess return of an investment relative to a benchmark,
adjusted for the risk taken.

A higher Information Ratio indicates a better risk-adjusted performance compared to the

benchmark, making it useful for evaluating active investment strategies.

 Jensen's Alpha
Jensen's Alpha is a performance metric that measures the excess return of an investment
compared to its expected return based on its risk level and market performance.

A positive Jensen's Alpha indicates that an investment has outperformed its expected return,
suggesting effective portfolio management.

 Sortino Ratio
The Sortino Ratio is a risk-adjusted performance measure that evaluates the excess return of an
investment relative to its downside risk. It is similar to the Sharpe Ratio but focuses only on
downside risk, making it more relevant for investors concerned with potential losses.

 Treynor Ratio
The Treynor Ratio is a risk-adjusted performance metric that measures the excess return
generated by an investment per unit of systematic risk taken. It is useful for comparing the
performance of investments with different levels of exposure to market risk.

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● Benchmarking and Investment Performance Evaluation

Benchmarks are reference points against which investment performance is measured and evaluated.
They provide a standard for comparison and help investors assess whether their investments meet their
objectives and outperform their peers.

Types of Benchmarks

 Market Indices
Market indices are broad market measures representing the performance of specific market
segments or asset classes. They are widely used as benchmarks for passive and active
investment strategies.

 Peer Group Comparison

Peer group comparison involves comparing the performance of an investment against a group
of similar investments or funds. This type of benchmarking helps investors evaluate the relative
performance of their investments within a specific category or style.

 Customized Benchmarks
Customized benchmarks are tailored to an investor's unique goals, risk tolerance, and
investment preferences. They provide a more personalized basis for performance evaluation
and decision-making.

● Factors Affecting Investment Performance

 Economic Conditions
Economic conditions, such as growth rates, inflation, interest rates, and fiscal policies, can
significantly influence investment performance. Investors should monitor these conditions and
adjust their strategies accordingly to optimize returns.

 Market Trends and Cycles

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Market trends and cycles, such as bull and bear markets, can also affect investment
performance. Understanding these trends and adapting investment strategies to different
market environments can enhance performance over time.

 Investment Strategy and Style

Investment strategy and style, such as value or growth investing, can impact performance due
to differing risk and return profiles. Aligning an investment strategy with an investor's objectives
and risk tolerance is critical for achieving desired performance.

 Portfolio Management
Effective portfolio management involves selecting, monitoring, and adjusting investments to
optimize performance and manage risk. Regular portfolio reviews and adjustments can help
maintain a balanced and diversified investment mix, contributing to better performance.

 Investor Behavior
Investor behavior, such as emotional decision-making or lack of discipline, can negatively impact
investment performance. Developing a disciplined investment approach and avoiding common
behavioral biases can help improve performance.

● Improving Investment Performance

a) Reviewing and Adjusting Investment Strategy
Regularly reviewing and adjusting investment strategies can help ensure they remain aligned
with an investor's objectives and risk tolerance, leading to improved performance over time.

b) Managing Risk Through Diversification and Asset Allocation

Managing risk through diversification and asset allocation is critical to improving investment
performance. A well-diversified and balanced portfolio can enhance returns while reducing
overall risk.

c) Monitoring Performance and Benchmarking

Monitoring investment performance and benchmarking against relevant indices or peers can
help identify areas of improvement and inform future investment decisions.

d) Learning from Past Performance and Mistakes

Learning from past performance and mistakes can lead to better decision-making and improved
investment performance. Analyzing what worked and what didn't can help refine investment
strategies and avoid repeating errors.

e) Seeking Professional Advice

Seeking professional advice from financial advisors or wealth managers can help improve
investment performance by providing expert guidance, personalized recommendations, and
ongoing support.