Selecting a risk-adjusted shareholder performance measure
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Christian S. Pedersen* and Ted Rudholm-Alfvin are senior managers at Mercer Oliver Wyman. Christian has worked with a range of European and global banks on all topics in risk management, primarily through leading Basel II, RAROC and firm-wide risk and capital management programmes. He has moreover published over 20 articles in risk, finance and economics. Ted has worked across a range of European and global banks, on topics such as VBM, capital management and RAROC programmes. *Mercer Oliver Wyman, 1 Neal Street, London WC2H 9PU, UK Tel: ⫹44 207 333 8333; Fax: ⫹44 207 33 8334; e-mail: [email protected]
Abstract The emergence of ‘alternative’ investment opportunities, the current bear market and the Wall Street analysts’ conflict of interest debacle have put pressure on current investment performance measurement methodologies. This paper presents a survey of classic and modern performance measures and assesses them against objective criteria. Depending upon the market, industry or group of assets studied and the preferences of investors, different measures gain favour, and key questions to address when selecting an appropriate performance measure are proposed. The arguments are demonstrated empirically for the global financial services sector, for which strong evidence in support of using Sharpe ratio-based measures is documented. As a comparison, the paper also looks at firms listed on the UK Alternative Investment Market (AIM), for which a divergence of rankings based on alternative measures is illustrated. General implications for risk management and asset allocations across different asset classes are discussed. Keywords: risk-adjusted performance; downside risk; asset management
Introduction The recent popularity of ‘alternative’ investment products has contributed to a search for performance measures capable of capturing different risk characteristics other than classic mean-variance based approaches. In particular, the traditional Sharpe ratio, introduced by Sharpe (1966) has recently been attacked. A good recent survey of arguments and references can be found in the Institutional Investor article by Lux (2002).
152
Journal of Asset Management
A scan of popular websites (eg www.cta-online.com, www.cradv.com or www.worthtrading.com) now reveals a wealth of different risk-adjusted performance measures attempting to meet increasing investor demand for rigour and transparency. This refocusing has been considerably fuelled by the present bear market and dismal performance of numerous fund managers, which accelerated fund withdrawals, and was most emphatically embodied in the
Vol. 4, 3, 152–172
䉷 Henry Stewart Publications 1479-179X (2003)
Risk-adjusted shareholder performance measure
Unilever vs Merrill Lynch case, in which the core arguments centred on basic risk/return analysis. It is thus timely to revisit some of the basic principles of performance measurement, and attempt to answer some key, but typically ignored, questions. Is it really the case that classic mean-variance assumptions underpinning t
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