Risk-Adjusted Performance Measures - NASDAQ - Case Study Example

Student name: Tutor: Course: Date:30/10/13 Introduction This paper aims at critically look at a portfolio performance in comparison with the market. The study also looks at the various principle of asset allocation imperatively applied in the task of asset allocation. Asset allocation entails making choice of the proportion of the assets which will be invested in each identified class of the assets[Gra04]. There is a range of classification which each given asset will fall. Stock should only be sold at the end of the investment horizon. The paper also observed that when most stock lead to a loss, however , it would be appropriate to sell the stock immediately if the value of is equal to buying price. Trading strategies In total I have made 78 transactions however between the period 2008 September 2013, I had not made no transaction because I had decided to observe the performance of the shares. My last transaction was on 24th Sep 2013 where I made a number of selling and buying which led me to making an overall loss of 24,336.72 which is equivalent to a negative return of 24. 34%. In the earlier periods, I engaged in overtrading which led to the loss since then I stopped trading and frequency of trading was zero. If I could have engaged in further trading then the following could have been the gains and losses for the four weeks. After 4 weeks the final portfolio weight changed because of the activities that took place in the market. From the final portfolio weight it appears that some of the stocks lost their value during past 4 weeks. That is the reason why the portfolio value decline. This is the main reason why portfolio selection and diversification is important. The diversification benefit does depend on the time period over which returns and variance are calculated. Some of the riskiness associated with individual assets can be eliminated by forming portfolios. The process of spreading an investment across assets is called diversification. The principle of diversification tells us that the spreading an investment across many assets will eliminate some of the risk. Not surprisingly, risks that can be eliminated by diversification are called “diversifiable” risks. The best and worst trade The worst trade was the investment in PAU3 which had no gain nor loss because it was not trading. Trading of short selling had the worst performance in the market because I made a loss from those sales. The price for these stocks was higher in 15th August 2013 as compared to the closing price on 24 September 2013. The best trading was AAPL because their shares appeared to have a positive as it increased in share price. It can be noted that these shares have an upward trend and their value is not very high. Computation of returns After 4 weeks the portfolio return were computed in comparison with the market. It appeared that the market outperformed the portfolio. From this analysis it is clear that they did not perform well. This is shown in the graph below The graph shows that the portfolio was underperforming S& P500 and the market except on September 30th when it performed well than the market. Cumulative Wealth The cumulative wealth of the portfolio, the S&P 500, NASDAQ and the DJIA appeared to take similar trends however the on 13th September, 2013 the portfolio performed well than the market. However the DJIA performed well than the portfolio and the S&P 500. This means that any investor who invested in the market, in DJIA and in this portfolio will have high return from the DJIA as compared to other two items. The graph below shows cumulative wealth for the 4 weeks Security, Portfolio and Market Statistics In order to determine whether the investment was risky or not various calculation were made which included variance, beta, systematic risks, standard deviation and arithmetic mean. The table below indicate each item Performance Measures   Ticker Arith Mean % Return E(r) Geom Mean % Return GM Cummulative Wealth CW (day 20) Return St Dev δ Risk Beta Systematic Risk β Sharpe Treynor Jensen Alpha   NASDAQ 0.30% 0.70% 6.53% 0.89% 0.84 0.22 0.0023 -0.249   ^GSPC 0.20% 0.60% 6.43% 0.91% 1.00 0.10 0.0009 -0.298   DJIA 0.15% 11.00% 6.39% 1.03% 1.03 0.05 0.0005 -0.307   Portfolio -24.15% 0.10% -16.39% 45.04% -1.36 -0.54 0.1790 0.163                     The standard deviation measures the risk of deviation from the mean. It shows the variability of the average mean thus the risk of not getting average return. In this case Gold - Electronic has a high variability in terms of returns followed by Netflix incorporated. Beta measures a risk that is not diversifiable. It shows how the price of the stick response to happenings in the market. Beta is calculated by relating the returns on the security with the returns for the market[Joh07]. Market returns is measured by the average return of a large sample of stocks such as the S&P500 Stock Index. The beta for the overall market is equal to 1.00 and others betas are viewed in relation to this value. All Betas are lie somewhere between -1.05 and 1.34. In this case it is clear that DJIA has the high risk of a beta of 1.34 and portfolio has -1.03. A reasonable surrogate of risk is the variability of return. This proxy measure in statistics is commonly the variance or standard deviation of the returns on a stock around the expected return[Lin65]. In reality the variation in return below what is expected is the best measure of risk but we saw that because the distributions of returns on stock is nearly normal in a statistical sense the semi-deviation or semi-variance below is expected value need not be calculated. Risk Adjusted Performance Measures When looking at Sharpe ratio we find that NASDAQ have high Sharpe ratio while S&P500 lowest Sharpe ratio. This is presented in the table below; Treynor ratio measures the portfolio excess return to the portfolio beta[Wil00]. In this case only NASDAQ has excess return to market beta the rest have a negative return. The portfolio is performing poorly. this means that in terms of reward to risk only portfolio has not returned excess profit to the market risk. Jensen attempts to construct a measure of absolute performance on a risk-adjusted basis. That is a definite standard against which performances of various funds can be measured. It is used to measure the ability of the manager to make good decision that will improve the portfolio performance of a company[Don06]. In other words we are attempting to determine if more than expected returns are being earned for the portfolio riskiness[Jor08]. There similarity between this model and the basis Sharpe and Treynros models. An implication of forms of the Sharpe and Treynor models is that the intercept of the line is at the origin. However Jensen’s alpha indicates that portfolio has excess return above the security line, the rest have a return that is negative. This is shown by the graph below Conclusion In regard, there have been ardent drives towards rethinking on how portfolios should be planned and in the fear that the buy and hold strategy never worked for investors in the wake of the downturn. My opinion is that a better investment strategy would involve investing some money during the dips and rebalancing the investment by periodically getting some of the assets back in order. This would be a mix of buy and hold, incisive market timing and diversification. As investment periods lengthen/as an investor gets older, it is necessary to put more into safer assets such as cash and bonds and less into equities. Further, diversifying within and among asset also helps to soften out volatility levels in downturns. Just because the word “sell” does not appear in the word “buy and hold” does not mean an investor cannot reposition his/her portfolio by changing things around. As such, buy and hold should be accompanied by effective rebalancing. Works Cited Gra04: , (Graham 126), Joh07: , (John Maginn 142), Lin65: , (Lintner 64), Wil00: , (Sharpe 78), Don06: , (Jordan. 675), Jor08: , (Miller 672), Read More