Performance Evaluation of Portfolio Managers

Performance Evaluation of Portfolio Managers

Performance evaluation of portfolio managers is a critical aspect of portfolio management. It is essential to measure the success or failure of a portfolio manager’s investment decisions to determine if the portfolio is meeting its objectives. Performance evaluation can be done using various methods, including comparing the portfolio’s return against a benchmark index, analyzing risk-adjusted returns, and evaluating the portfolio’s performance relative to its peers.

One commonly used method for evaluating the performance of a portfolio manager is to compare the portfolio’s return against a benchmark index. A benchmark index is a standard against which the portfolio’s performance can be measured. For example, a portfolio manager who invests in U.S. stocks may use the S&P 500 index as a benchmark. If the portfolio’s return is higher than the S&P 500 index, then the portfolio manager has outperformed the benchmark. On the other hand, if the portfolio’s return is lower than the S&P 500 index, then the portfolio manager has underperformed the benchmark.

Manager Universe Comparison

A Manager Universe Comparison is the comparison of one portfolio manger’s performance to a group of comparable portfolio managers. The comparison may also be with another term for the manager peer group. This is done periodically to maintain competitiveness and to judge a particular manager’s performance.

There are multiple reasons for the popularity of this comparison. Universes and peer group comparisons provide an actively managed benchmark alternative to a passive index benchmark. It has clearly defined and effectively constructed universes and peer groups can be used to measure almost any well understood investment style. Portfolio-specific investment restrictions can be incorporated into a well constructed universe and peer group. Finally, it is also conceptually easy to explain and understand.

There have been however a few criticisms about the proactice. Universe and peer group comparisons have conceptual shortcomings compared to an appropriate benchmark index. Universes and peer groups exhibit survivorship bias, which become more pronounced over longer time horizons. The system is a poor conveyor of a manager’s style and does not pass objective quality tests.

Subjective Vs. Objective Comparison

To compare performance, figure amongst the mandates requires a scale on which one can assess how well or how badly a manager has performed. The reference universe is divided into four quartiles. For statistical relevance the upper and lower ends of the distribution are trimmed. Percentile ranks should be used to maintain comparability over time in universe of changing size. A statistical scale is indeed objective compared to raw experience. If portfolios are not selected carefully, one might have a statistical scale but it cannot be interpreted clearly. Therefore, the quality of the reference universe determined by the control over the portfolio chosen is one of the most significant added values of comparative performance measurement.

Comparison with Benchmarks  

Comparison of a manger’s performance with a specified benchmark is an important step in evaluating a manager’s performance. The portfolio under consideration will always have a feasible alternative portfolio in the form of a benchmark portfolio. The basis of asset allocation decisions is directly related to the scale of performance evaluation. Only those benchmarks that are representative of the manager’s style and strategies should be used. The proof of a superior skilled manager can be determined by comparing the performance of a managed portfolio against a suitable benchmark, but this will only hold significance when the index reflects the manager’s style.

 

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