subject: MEASUREMENTS OF DIFFERENT PARTS OF THE PORTFOLIO [print this page] MEASUREMENTS OF DIFFERENT PARTS OF THE PORTFOLIO
MEASUREMENTS OF DIFFERENT PARTS OF THE PORTFOLIO
The article has so far discussed measurements of risk and returnfor the whole portfolio in evaluating the skill with which it has beenmanaged. One might ask at this point whether it is also necessaryto measure the risk and return separately for the different classes ofassets in the portfolio. Is it necessary, for example, to measure therisk and return on the equity portion, on the bonds, on convertiblesecurities, and so forth?
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One of the maxims of Markowitz which should be given greatweight is that investors should think of themselves as choosing portfolios rather than securities so that the performance of investors shouldbe judged by the total portfolio rather than by individual securitiesor groups of securities. Although it is fairly standard practice to measure the risk and return for different kinds of assets, the purpose shouldbe diagnosis rather than the overall evaluation of portfolio management. Such separate measurements can cast light on the reasons for superior or inferior performance, and such potential illumination isdiscussed in the next article. At this point, perhaps all that is necessary is to show why such measurement should not be relied upon to indicate the skill with which a total portfolio is managed.
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The basic objection to reliance on measurements for separate classes of securities is that they fail to take account of the relationships andinteractions among classes of securities. Just as it is foolish to attemptto measure the risk and return on an individual asset apart from itsrelationships to the rest of the portfolio, so it is foolish to measurethe risk and return for individual groups of assets apart from theirrelationships to the other parts of the portfolio. In fact, one of theclear lessons of portfolio theory is the impossibility of getting a meaningful measurement of the riskiness of an individual assetor groupof assetsapart from the other assets with which they are combinedto form an investor's portfolio. The most dramatic example wouldbe a security or group of securities which are negatively correlated with the portfolio. Viewed in isolation, such securities might seemvery risky with the consequent expectation of a large risk premium.Viewed together with the rest of a portfolio, such securities wouldcorrectly be judged to be risk reducing and consequently would beexpected to have a very small or even negative risk premium.
