[MUSIC] Hi there, this module assessing performance is made of three lessons. In the first one, we'll have a look at absolute versus relative performance. This is a key concept, which is central to the industry of fund management. Do you measure yourself in absolute terms or in relative terms? You'll see what that means. Then in lesson two, we will focus on performance measurement and here too we will see some key notions. That of the sharp ratio for instance, which is very common in the fund management industry. For it provides a unique measure of risk adjusted returns. And in the third lesson, we'll have a look at something which is also key in the fund management business. It's the notion of performance attribution and analysis, okay. So, the learning outcomes of this course will be to give you some insight as to how to measure absolute versus relative performance. And in so doing to define the right benchmark, to choose the right benchmark. We'll also see how you may be tempted at times and we see under which condition. You may be tempted to shift away from a relative performance mandate to one which is driven by absolute returns. And we'll see that this has a lot to do with psychology and emotions. And finally, we will see how you can measure performance attribution. And make an analysis to find out whether a manager is really doing what he claims he's doing. So, just to give you a little bit of insight into what we're going to see more details in this course. Let's take a look here at the definition of what the correct benchmark is. Or more precisely, let's start by defining what It should not be. Typically, we find that investors, more often than not use the stock market index of their home country as the benchmark. This is not the correct way of going about this. Unless, obviously. Your wealth is managed in an equity only portfolio and exclusively focused on the equities of your home country. In that case, obviously the benchmark is the correct one but more often than not, it's just an index which is picked. Say, you're a Swiss investor and you look at the Swiss Performance Index. The SPI which is the benchmark here in Switzerland for the equity market. But clearly if you're investing internationally, that Swiss part of the equity portfolio, will only account for a tiny fraction of your wealth. Hence, it is not appropriate to focus on this kind of benchmark. Quite often also, we would hear that a benchmark would be, say a friend has an account to some wealth manager competition. And he comes to you and says, [SOUND] could you believe it? Last year I made something incredible, I made 17% on my assets. So, you might be tempted at that point to go to your own banker and say, hey, come on. What are you doing? I am only making 7%, my friend dot, dot competitor XYZ is making 17%. This is something also that we should refrain from doing. More often than not, there tends to be some overestimation of the return you make in a specific year. So, maybe what your friend has forgotten to mention is that. That 17% return last year came after a series of years which were sharply negative. And so, that 17% only partially compensates for the loses you made in the previous years. Because maybe his wealth manager took excessive risk. So, this notion risk here comes regularly on the lies much of the material you will see here in this course. So, the notion that you should not look at performance alone. But also focus on the risk which has been taken to deliver that kind of return and lastly a benchmark is not what you gained last year. There's always this idea which is very clearly indicated in all the documents. Which are provided by people in the wealth management industry. Is that past returns are no guarantee for future returns. And that's a key thing to know and to accept that this is the rule of the game. You should not extrapolate, it's not because one in a given year you make a 25%. That you should expect in the following year to also make a 25% as a return on your investments. We will see in this course also some metrics, and here it will be a bit more technical, as to how to measure performance attribution. This is a bit more technical, as I just said, but for one simple reason. Here we're going really into the details to find out whether a manager is really doing what he says he's doing. For that, we will see that various ways to measure this performance attribution. The first one is focus on fundamentals. We do some kind of regression, we estimate the portfolio returns on various factors. Here I indicated some, the P/E ratio, remember we saw that when we studied the how to value an asset or an equity market. And we'll also look at the economy. We'll also look at the duration of bonds. You remember duration, the ruler. [LAUGH] And the glasses and the bottle that fell. Anyway, so that's the sensitivity of your bond to the movements in interest rates. And so, basically we take all these factors and we see how a portfolio is linked to these various factors. And then we're able to say, okay, maybe 60% of these returns come from strategies on the PEs. The manager will be some kind of value investor, buying when the PE is low and selling when the PE is high. Or possibly would also take bets on the bond market and by extent duration. When he expects interest rates to drop and conversely, so things are like that. Then the second way to measure performance decomposition is something which is more widely used. And it's also [LAUGH] By William Sharpe, so Sharpe Ratio, widely used. And style analysis also by William Sharpe is also widely used. And the style analysis, it's the same kind of spirit as in the previous one, the multi factor analysis. But here we tend to focus on specific styles. For instance, value, typically and also small versus large caps. So, here we would want to see if a manager pretends he is a value investor and he specialize on small cap. Then we will see, we will make a regression of the portfolio return, the fund return on two indices. Which capture this value style, and also the small cap versus large cap style. And we'll see how the fund correlates with these two factors to see if there's really a strong correlation. A high correlation between the value style, the small cap style and the returns of the fund manager. And lastly, we also have a return decomposition to find out how much in a portfolio comes from in the terms of returns, comes from the top-down approach. Remember the top-down you start from the global microeconomic picture. Then you derive some views on the sectors to over under-weight and then the stocks. And the bottom-up perspective which starts from the bottom. Identifies the companies for their fundamentals and their attractive valuation and builds the portfolio from the bottom. And basically, here the decomposition will come with a result and say okay. For this kind of portfolio, we can say that maybe 2/3 of the returns come from the asset allocation decision, the market timing, the top-down bit. And only 1/3 comes from individual security selection. So, here and maybe also a fund manager which pretends he is a good stock picker. Well, actually, the results will show that he makes more money with market timing, as opposed to stock selection. So, this performance attribution is more technical but indeed is key also when we are dealing with fund management. Because here we really want to make sure that as we say, the manager puts his money where his mouth is. He does what he claims he is good at. So, we want to check for instance, if he's good at picking stocks, if he's good at market timing, if he's a value investor or small cap specialist. What else? Avoiding losses. This is more for the hedge fund type of manager because here we are in an absolute return environment. Where the fund manager should deliver positive returns, normally irrespective of market conditions. Irrespective of what the benchmark is delivering, return-wise. And also connected to this hedge fund strategies, we want to see if the hedge fund manager makes money on his short positions. And the short book is not just a hedge book of the long positions, but also something which delivers a positive alpha. [MUSIC]
