Portfolio evaluation models are used by investors to measure the performance of their investment portfolio. These models are designed to help investors understand how well their portfolio has performed over a given period of time, and to make informed decisions about their investment strategy going forward. In this article, we will discuss the most commonly used portfolio evaluation models.
1. Sharpe Ratio:
The Sharpe ratio is a measure of risk-adjusted return, which is calculated by subtracting the risk-free rate of return from the portfolio's return, and then dividing the result by the portfolio's standard deviation. This ratio helps investors to evaluate the excess return they are getting for the level of risk they are taking. A higher Sharpe ratio indicates better risk-adjusted performance.
2. Treynor Ratio:
The Treynor ratio is another risk-adjusted performance measure that takes into account the portfolio's beta, which measures its sensitivity to market movements. This ratio is calculated by dividing the excess return of the portfolio over the risk-free rate by its beta. The Treynor ratio helps investors to evaluate the performance of their portfolio in relation to the systematic risk they are taking on.
3. Jensen's Alpha:
Jensen's Alpha is a measure of the excess return earned by the portfolio above what would be expected given its beta and the risk-free rate of return. This measure helps investors to evaluate whether the portfolio manager has added value above what would be expected given the level of systematic risk they are taking on.
4. Information Ratio:
The Information Ratio is a measure of the portfolio manager's ability to generate excess returns relative to a benchmark index, adjusted for the amount of risk taken on. This ratio is calculated by dividing the excess return of the portfolio by the portfolio's tracking error, which measures how closely the portfolio tracks the benchmark index.
5. Sortino Ratio:
The Sortino ratio is a modified version of the Sharpe ratio that takes into account only the downside risk of the portfolio, as measured by the portfolio's semi-variance. This ratio helps investors to evaluate how well the portfolio is protected from losses, particularly during periods of market volatility.
In conclusion, portfolio evaluation models are important tools that help investors to evaluate the performance of their investment portfolio. Each model has its strengths and weaknesses, and investors should choose the one that best suits their needs and investment objectives. By regularly evaluating their portfolio using one or more of these models, investors can make informed decisions about their investment strategy and ensure that their portfolio is meeting their financial goals.
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