Investments, tenth edition

  Adjusting Returns for Risk 

 Evaluating performance based on average return alone is not very useful. Returns must be 

adjusted for risk before they can be compared meaningfully. The simplest and most popu-

lar way to adjust returns for portfolio risk is to compare rates of return with those of other 

investment funds with similar risk characteristics. For example, high-yield bond portfolios 

  

2

 Excel’s function XIRR allows you to input sums at any date. The function provides the IRR between any two 

dates given a starting value, cash flows at various dates in between (with additions given as negative numbers, and 

withdrawals as positive values), and a final value on the closing date. 

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are grouped into one “universe,” growth stock equity funds are grouped into another uni-

verse, and so on. Then the (usually time-weighted) average returns of each fund within the 

universe are ordered, and each portfolio manager receives a percentile ranking depending 

on relative performance with the    comparison  universe    .  For example, the manager with 

the ninth-best performance in a universe of 100 funds would be the 90th percentile man-

ager: Her performance was better than 90% of all competing funds over the evaluation 

period.  

3

   The nearby box reports on Vanguard’s recent revamp of its benchmark indexes for 

several asset classes.   

 These relative rankings are usually displayed in a chart such as that in  Figure 24.1 . The 

chart summarizes performance rankings over four periods: 1 quarter, 1 year, 3 years, and 

5 years. The top and bottom lines of each box are drawn at the rate of return of the 95th 

and 5th percentile managers. The three dashed lines correspond to the rates of return of the 

75th, 50th (median), and 25th percentile managers. The diamond is drawn at the average 

return of a particular fund and the square is drawn at the return of a benchmark index such 

as the S&P 500. The placement of the diamond within the box is an easy-to-read represen-

tation of the performance of the fund relative to the comparison universe.  

 This comparison of performance with other managers of similar investment style is a use-

ful first step in evaluating performance. However, such rankings can be misleading. Within 

a particular universe, some managers may concentrate on particular  subgroups, so that 

Initial contribution

10,000.00

Data

$ 

Initial

Price

# of 

Shares

Monthly

Dividend

Total

Dividend

End

Price

(S1) Dividend-yielding security

5,000.00

$   

9.50

$    

526

0.30

$      

157.89

$

13.00

$       

(S2) Non-dividend-yielding security

5,000.00

$   

9.50

$    

526

0

0

11.00

$       

(S3) Non-div yielding security (03/12)

8,000.00

$   

8.80

$    

909

0

0

13.50

$       

1-Mar-11

(10,000.00)

1-Apr-11

157.89

2-May-11

157.89

1-Jun-11

157.89

1-Jul-11

157.89

1-Aug-11

157.89

1-Sep-11

157.89

3-Oct-11

(5,631.58)

1-Nov-11

157.89

$

$

$

$

$

$

$

$

$