Explanation:
The Treynor measure is most appropriate for comparing well-diversified portfolios. That is, the Treynor measure is the best to compare the excess returns per unit of systematic risk earned by portfolio managers, provided all portfolios are well-diversified.
All three portfolios managed by Donaldson Capital Management are likely less diversified than the market portfolio. The standard deviation of returns for each of the three portfolios is higher than the standard deviation of the market portfolio, reflecting a low level of diversification.
Jensen's alpha is the most appropriate measure for comparing portfolios that have the same beta. The Sharpe measure can be applied to all portfolios because it uses total risk, and it is more widely used than the other two measures. Also, the Sharpe ratio evaluates the portfolio performance based on realized returns and diversification. A less-diversified portfolio will have higher total risk, and vice versa.
(Book 1, Module 5.3, LO 5.g)
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Question 28
Donaldson Capital Management, a regional money management firm, manages nearly $400 million allocated among three investment managers. All portfolios have the same objective, which is to produce superior risk-adjusted returns (by beating the market) for their clients. You have been hired as a consultant to measure the performance of the portfolio managers. You have collected the following information based on the last 10 years of returns.
| Portfolio Manager | Mean Annualized Rate of Return | Beta | Standard Deviation of Return |
|---|---|---|---|
| A | 0.18 | 1.35 | 0.24 |
| B | 0.21 | 1.95 | 0.25 |
| C | 0.24 | 2.10 | 0.22 |
During the same time period, the average annual rate of return on the market portfolio was 13% with a standard deviation of 19%. In order to assess the portfolio performance of the above managers, you should use the:
A
Treynor measure of performance.
B
Sharpe measure of performance.
C
Jensen measure of performance.
D
Sortino measure of performance.
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