Modern Portfolio Theory: Foundations, Analysis, and New Developments, + Website

Chapter 18

Portfolio Performance Evaluation

Most professional money managers provide material that describes their portfolio services in a flattering manner. Potential investors should beware of such promotional materials. Investors should investigate before they invest.

An abundance of widely accepted folklore is used in the investments industry. When erroneous beliefs are discredited and folklore is replaced with scientific methods portfolio analysis will advance. In the meantime, loanable funds will be misallocated and research expenditures will be squandered on charlatans.

To evaluate the investment performance of portfolios, we introduce Nobel Prize–winning economic models. Then, empirical data from mutual funds is used to populate the economic models with data and demonstrate how to analyze the successes and failures of professional investment managers. The performances of open-end investment companies are evaluated. Mutual funds, as they are nicknamed, are studied because (1) their advertisements promising investors the benefit of “professional money management” raise questions as to whether the services are worth their price, and (2) the Investment Company Act of 1940 and the Securities Exchange Commission (SEC) require that mutual funds' data be made readily accessible to the public. U.S. securities law is based on the legal concept of “full disclosure”. The phrase full disclosure refers to the idea that financial transparency will reduce deception and facilitate better ...