Explanation:
The Sharpe measure uses the standard deviation of returns as the measure of risk whereas the Treynor measure uses beta (systematic risk).
The Sharpe measure, therefore, evaluates the portfolio manager on the basis of both the rate of return performance and diversification.
For a completely diversified portfolio, one without any unsystematic risk, the two measures give identical rankings because the total variance of the completely diversified portfolio is its systematic risk.
On the other hand, a poorly diversified portfolio has a higher ranking on the basis of the Treynor measure but a much lower ranking on the basis of the Sharpe measure.
The difference in rank emerges from the difference in diversification.
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Q.3190 Jack Marconi is an equity strategist at Gandhara Investment and is evaluating the performance of four large-cap equity portfolios: Azgard, Lambda, Tricky, and Jackpot. As part of his analysis, Jack computes the Sharpe ratio and the Treynor measure for all four funds. Based on his finding, the ranks assigned to the four funds are as follows:
| Fund | Treynor Measure Rank | Sharpe Ratio Rank |
|---|---|---|
| Azgard | 1 | 4 |
| Lambda | 2 | 3 |
| Tricky | 3 | 2 |
| Jackpot | 4 | 1 |
The difference in rankings for Funds Azgard and Jackpot is most likely due to:
A
Different benchmarks used to evaluate each fund's performance.
B
A difference in risk premiums.
C
Poor diversification in Azgard Fund relative to Jackpot Fund.
D
None of the above.