AnalysisGlobal Frameworks: GIPS (Global Investment Performance Standards), CFA Syllabus.
1. Risk-Adjusted Performance Metrics
Raw portfolio returns do not reveal whether a manager generated outperformance through genuine skill or by taking on excessive risk. Analysts use standardized metrics to evaluate risk-adjusted performance:
  • Sharpe Ratio: Measures excess return per unit of total risk. It is the standard metric for evaluating a user’s total investment portfolio:

    Sharpe Ratio = (R_p − R_f) / σ_p

 

  • Treynor Ratio: Measures excess return per unit of systematic risk. It is best suited for evaluating individual funds meant to serve as sub-components within a broader, fully diversified portfolio:

    Treynor Ratio = (R_p − R_f) / β_p

 

  • Jensen’s Alpha: Measures a portfolio’s excess return above the theoretical return predicted by the CAPM framework:

    α_p = R_p − [R_f + β_p (R_M − R_f)]

 

  • Information Ratio: Measures a manager’s ability to generate excess returns relative to a specific benchmark per unit of active risk (tracking error):

    Information Ratio = (R_p − R_benchmark) / Tracking Error)

2. Brinson-Fachler Attribution Decomposition
To pinpoint exactly how a manager generated returns, attribution analysis breaks down performance into two distinct decisions:
  • Allocation Effect: The value added or lost by over- or underweighting entire asset classes or sectors relative to the benchmark.
  • Selection Effect: The value added or lost by selecting specific securities within those individual sectors relative to the benchmark’s choices.

 
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