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: Treynor Measure Fund Sharpe Ratio A 1 4 В 2 3 C 3 2 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 1

1.Treynor ratio is the best measure when the portfolio is well diversified, When the portfolio is well diversified then the unsystematic would have been already reduced due to diversification, thus as treynor ratio uses beta which calculates systematic risk only. In contrast sharpe ratio uses standard deviation which calculates total risk, thus it is best measure for the portfolio which is not well diversified.

2.Thus as D has 4 and 1 of Treynor and sharpe ratios respectively indicates that D is well diversified whereas A is not.

Therefore the answer is A Lack of Diversification in fund A as compared to fund D.