Bill Smith is evaluating the performance of four large-cap equity portfolios: fu
ID: 2783627 • Letter: B
Question
Bill Smith is evaluating the performance of four large-cap equity portfolios: funds A, B, C and D. As part of his analysis, Smith computed the Sharp ratio and the Treynor measure for all four funds. Based on his finding, the ranks assigned to the four funds are as follows:
Fund Treynor Measure Sharpe Ratio
A 1 4
B 2 3
C 3 2
D 4 1
The difference in rankings of funds A and D based on the Sharp ratio and the Treynor measure is most likely due to:
Different benchmarks used to evaluate each fund’s performance.
A lack of diversification in fund D as compared to fund A.
A lack of diversification in fund A as compared to fund D.
A difference in risk premiums.
A difference in systematic risk
?? Answer is not A.
Explanation / Answer
It is due to diversification in Fund A.
The Sharpe ratio measures excess return per unit of total risk, while the Treynor ratio measures excess return per unit of systematic risk.
Since Fund A performed well on the Treynor measure and so poorly on the Sharpe Measure, it seems that the fund carries a greater amount of unsystematic risk, meaning it is not well-diversied and systematic risk is not the relevant risk measure.
Answer would be lack of diversification in fund A as compared to fund D
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