Portfolio Performance Measurement › Summary

This chapter developed the essential toolkit for evaluating portfolio performance beyond raw returns. The key metrics and their applications include:

Absolute risk-adjusted measures:

• The Sharpe ratio normalizes excess returns by volatility, which allows comparison across portfolios with different risk levels
• The Sortino ratio focuses on downside risk, making it appropriate for asymmetric return distributions

Relative performance measures:

• Active return and tracking error quantify how a portfolio differs from its benchmark
• The information ratio measures the efficiency of active management by relating alpha to active risk

Path-dependent risk measures:

• Maximum Drawdown captures the worst peak-to-trough decline, revealing tail risks that volatility misses
• The Calmar ratio relates returns to this worst-case scenario, penalizing strategies with catastrophic losses

Each metric illuminates a different aspect of performance, and no single number tells the complete story. Skilled performance evaluation requires examining multiple metrics together, understanding their limitations, and considering the statistical uncertainty inherent in finite samples.

In the next chapter on Performance Attribution, we'll decompose portfolio returns into their sources: how much came from market exposure, sector allocation, security selection, and timing. This analysis connects the performance metrics developed here to the underlying investment decisions that generated them.