Question about RAPM

[sleepybird]

Sharpe ratio is good for portfolios that are not well diversified (because it accounts for total risk).
Treynor and Jensen’s are appropriate for evaluating the performance of a well diversified portfolio (because it only accounts for systematic risk).
What about the information ratio? Total risk or systematic risk?
On one hand, tracking error is a standard deviation measure (total risk) but it’s a standard deviation from the CAPM (systematic risk).

 

[David Harper CFA FRM]

Hi sleepybird,

Here is what Amenc says:

"The information ratio is therefore an indicator that allows us to evaluate the manager’s level of information compared with the public information available, together with his skill in achieving a performance that is better than that of the average manager. Since this ratio does not take the systematic portfolio risk into account, it is not appropriate for comparing the performance of a well-diversified portfolio with that of a portfolio with a low degree of diversification." -- p 115

I think he suggests something natural, that the key appropriateness is consistency between the portfolio and the benchmark. (When i worked with IRs as a consultant, we didn't assume diversification, the issue was selecting the right benchmark/paper portfolio). For example, surely it's appropriate to benchmark a style-specific portfolio (e.g., sector, capitalization) which, by broad definition, is not diversified ... and then the benchmark is similarly non-diversified.

Thanks, David