The Complete Guide to Portfolio Performance

An intuitive and effective desk reference for performance measurement in asset and wealth management

In The Complete Guide to Portfolio Performance: Appraise, Analyse, Act, a team of finance professors with extended practical experience deliver a hands-on desk reference for asset and wealth managers suitable for everyday use. Intuitively organized and full of concrete examples of the real-world implementation of the concepts discussed within, the book provides a comprehensive coverage of all important portfolio performance matters across 18 chapters of actionable and clearly described content. The authors have provided relevant cross-referencing where appropriate, “Key Takeaways and Equations” sections at the end of each chapter, and pointers to additional resources for anyone interested in pursuing further research.

You'll also find:

• Discussions of more than a hundred classical and modern performance measures organized logically and with a focus on their applications
• Strategies for selecting appropriate performance measures based on your situation as a manager or investor
• Explanations of analytical techniques (statistical approaches, attribution, fund ratings...) enabling a comprehensive use of performance-related information
• Applications of portfolio performance criteria in concrete investment decision-making processes
• Highly actionable and logically organized material that's easy to find at a moment's notice
• A full set of pedagogical powerpoint slides and excel worksheets with all data and formulas

Perfect for investors, portfolio managers, advisors, analysts, and regulators, The Complete Guide to Portfolio Performance is also a must-read reference for students and practitioners of asset and wealth management, as well as those pursuing certification such as CFA, CIPM, CIIA, and CAIA.

Preface xxvii

Acknowledgements xxxi

About the Website xxxiii

Chapter 1 The Scope of Portfolio Performance 1

1.1 From Portfolio Management to Portfolio Performance 2

1.2 Rolling Out the Three Layers of Performance Evaluation 10

1.3 Returns, Risk, and Benchmarks 17

Key Takeaways and Equations 27

References 30

Part I Classical Performance Measurement 33

Chapter 2 Standard Portfolio Theory and the CAPM 35

2.1 The Portfolio Allocation Problem 37

2.2 The Market Portfolio and the Security Market Line 45

2.3 Implementing the CAPM 53

2.4 Multifactor Models 64

Key Takeaways and Equations 72

References 73

Chapter 3 Classical Portfolio Performance Measures 77

3.1 Peer Group Comparisons 80

3.2 The Sharpe Ratio 87

3.3 The Treynor Ratio, Jensen’s Alpha, and the Modified Jensen’s Alpha 100

3.4 The Information Ratio 114

Key Takeaways and Equations 126

References 129

Chapter 4 Selecting a Classical Performance Measure 131

4.1 Risk and Measurement Dimensions 134

4.2 Choosing a Measure for the Investor: The Normative Approach 140

4.3 Choosing a Measure for the Investor: The Positive Approach 154

4.4 Choosing a Measure for the Manager 167

Key Takeaways and Equations 177

References 180

Chapter 5 Pitfalls and Dangers with the Classical Performance Measures 183

5.1 Issues with the Standard Portfolio Theory Framework 185

5.2 Issues with the Capital Asset Pricing Model 197

5.3 Issues with the Sample 210

5.4 Issues with the Regressions 223

5.5 Issues with the Interpretations 233

Key Takeaways and Equations 247

References 250

Part II Developments in Performance Measurement 253

Chapter 6 The Classical Performance Measures Revisited 255

6.1 Refinements of the Sharpe Ratio 258

6.2 Alterations of the Sharpe Ratio 276

6.3 Alternative Versions of the other Classical Performance Measures 297

6.4 Classical Performance Measures as Risk-Adjusted Returns 305

Key Takeaways and Equations 318

References 321

Chapter 7 Performance Measurement in Multifactor Models 325

7.1 Types of Linear Multifactor Models 327

7.2 The Multifactor Alpha and the Multifactor Modified Alpha 345

7.3 Other Classical Performance Measures Adapted to Multifactor Models 357

7.4 Measuring Performance in Special Cases of Multifactor Models 364

Key Takeaways and Equations 373

References 376

Chapter 8 Performance Measurement with Market Timing 381

8.1 Piecewise-linear Regression Approach 385

8.2 Polynomial Regression Approach 400

8.3 Return-based Dynamic Exposures Approach 414

8.4 Holding-based Dynamic Exposures Approach 424

8.5 A Roadmap for Market Timing Performance Appraisal 434

Key Takeaways and Equations 440

References 443

Chapter 9 Preference-based Performance for the Standard Investor 447

9.1 The Structure of the Rational Investor’s Preferences 450

9.2 Preference-based Performance in the Standard Portfolio Theory 456

9.3 Performance Measurement with Standard Utility functions 468

Key Takeaways and Equations 481

References 484

Chapter 10 Preference-based Performance for the Behavioral Investor 487

10.1 The Structure of the Behavioral Investor’s Preferences 489

10.2 Performance Measurement with Behavioral Utility 494

10.3 Performance as Ratios of Gains Over Losses 504

10.4 Mental Accounting and Portfolio Performance 519

Key Takeaways and Equations 534

References 537

Part III Analyzing and Monitoring Performance 541

Chapter 11 Navigating the Maze of Portfolio Performance 543

11.1 The Spectrum of Performance Measurement 544

11.2 Ariadne’s String Taxonomy 573

11.3 Analytical Sorting Approaches 581

11.4 Statistical Sorting Approaches 593

11.5 Dashboard 603

Key Takeaways and Equations 607

References 610

Chapter 12 Performance Design for Specific Asset Classes 613

12.1 Fixed-Income Portfolio Returns 615

12.2 Performance Framework for Fixed-Income Portfolios 622

12.3 Illiquid Alternative Investment Portfolio Returns 635

12.4 Performance Framework for Hedge Funds 643

12.5 Performance Framework for Private Equity 650

Key Takeaways and Equations 663

References 666

Chapter 13 The Granular Analysis of Performance 671

13.1 The Fundamentals of Performance Decomposition 678

13.2 Attributing Performance 686

13.3 Decomposing Risk-adjusted Performance Ratios 700

Key Takeaways and Equations 714

References 718

Chapter 14 Performance Attribution Methods 719

14.1 Attribution Analysis for a Single Period 724

14.2 Multiperiod Attribution Analysis 744

14.3 Extending the Scope of Attribution Analysis 752

14.4 Statistical Performance Attribution 774

Key Takeaways and Equations 785

References 789

Part IV Using Performance for Decision-making 791

Chapter 15 Disclosing and Verifying Portfolio Performance 793

15.1 The Global Investment Performance Standards 794

15.2 Communicating Fund Performance Effectively 802

15.3 Communicating Personal Portfolio Performance Effectively 813

15.4 Fund Ratings and Portfolio Analytics 818

Key Takeaways and Equations 829

References 831

Chapter 16 Applications of Performance in Investment Decisions 835

16.1 Using Performance to Determine the Investment Universe 837

16.2 Using Performance for Portfolio Strategy Design 847

16.3 Using Performance to Serve Investor Needs 867

16.4 Reconciling ESG Investments and Performance 886

Key Takeaways and Equations 901

References 905

Chapter 17 Performance and Predictability 907

17.1 What does Predictability Encompass? 910

17.2 Absolute Persistence 925

17.3 Relative Persistence with Recursive Portfolios 944

17.4 Relative Persistence with Matched Rankings 961

Key Takeaways and Equations 972

References 975

Chapter 18 Agency Issues and Illusion of Performance 979

18.1 The Standard Agency Framework 980

18.2 How to Mitigate Agency Conflicts? 986

18.3 Performance Measurement and Agency Issues 998

18.4 Designing a Normative Performance Measure 1013

18.5 The Role of Luck in Performance Measurement 1023

Key Takeaways and Equations 1029

References 1031

Index 1037

PASCAL FRANÇOIS is Professor of Finance at HEC Montréal. He is the founding director of the Canadian Derivatives Institute and a former co-editor of Finance, the academic journal of the French Finance Association. He holds a PhD from Sorbonne University and ESSEC.

GEORGES HÜBNER is Professor of Finance at HEC Liège (Liège University, Belgium). Georges serves as a non-executive director at Belfius Bank and Belfius Asset Management, as well as an expert member of the investment committee of the CERN pension fund (Geneva). He is also the founder of two fintech companies, Gambit Financial Solutions and Sopiad. He holds a PhD from INSEAD.

AN EFFICIENT AND EFFECTIVE DESK REFERENCE FOR ASSET AND WEALTH MANAGEMENT PROFESSIONALS AND STUDENTS

In The Complete Guide to Portfolio Performance: Appraise, Analyse, Act, a team of distinguished finance professors with practical experience delivers a comprehensive guide to all aspects of portfolio performance from the perspective of investors, portfolio managers, analysts, and regulators. In the book, you’ll explore the core topics of portfolio performance measurement in a realistic and rigorous way. You’ll find actionable and clearly illustrated content with practical examples that demonstrate the application of the concepts discussed within.

The authors clearly organize the material inside, making information easy to find and highly discoverable. The book is structured in four parts and eighteen chapters, contains relevant cross-referencing, as well as a “Key Takeaways and Equations” section at the conclusion of each chapter. They’ve also provided pointers to specialized sources for those interested in conducting additional research.

Perfect for professionals and students alike, The Complete Guide to Portfolio Performance is the hands-on roadmap to the subject that investors, securities analysts, financial regulators, and investment managers have been waiting for.

PRAISE FOR THE COMPLETE GUIDE TO PORTFOLIO PERFORMANCE

“This is indeed a Complete Guide to Portfolio Performance. The authors have described a range of possible measures and evaluated their usefulness in theory and in practice. It will serve as both an introduction to this important subject and a reference work for those concerned with measuring and analyzing the performance of investment portfolios.”
— William F. Sharpe, Professor Emeritus, Stanford University, Nobel Prize in Economic Sciences 1990

“Performance measurement has expanded in many directions over the last decades. François and Hübner provide a much needed, ambitious synthesis. Their Complete Guide to Portfolio Performance is the reference that should always be within immediate reach, with the confidence that insightful answers about any question related to portfolio performance will be found. The authors do not only effectively synthesize the state-of-the-art knowledge in the field, but they also bring their own original and specific contributions on many occasions. A massive tour de force.”
— Frank J. Fabozzi, Professor of Practice, The Johns Hopkins University, Carey Business School. Editor of The Journal of Portfolio Management

“The book analyzes many facets of performance appraisal but also explains how it is integrated within the portfolio management process. Each topic is reviewed with rigor and augmented with practical and easy-to-implement examples.”
— Naïm Abou-Jaoudé, Chief Executive Officer, New York Life Investments Management

“Measuring and communicating portfolio performance in a transparent and faithful manner are key to deserve the trust of the investor. This impressive book constitutes a major contribution to this important field for all financial market participants.”
—Jean-Paul Servais, Chairman of the FSMA and IOSCO