Asset allocation and downside risk. (4th June 2021)

• Record Type: Journal Article
• Authors: Barber, Joel R.
• Is Part Of: International journal of portfolio analysis & management. Volume 2:Number 3(2021)
• Page Start: 268
• Page End: 284
• Publication Date: 2021-06-04
• Subjects: asset-class models -- downside risk -- performance measurement -- Sharpe ratio -- Sortino ratio; Investment analysis -- Periodicals; 332.605
• Languages: English
• ISSNs: 2048-2361

Abstract

Economists have long recognised that investors care more about downside risk than total variation, which includes upside gains. This paper develops a new technique, along the lines of Sharpe's (1990, 1992) asset-class model, to measure the performance of an actively managed portfolio with respect to downside risk. The new technique involves choosing a multiple asset-class benchmark with the highest possible correlation with the active strategy return subject to the constraint that the risks are the same. The risk-matched portfolio can be used to measure the performance of an active portfolio with respect to downside risk. Because, by construction the risk of the benchmark is the same as the active portfolio, it is a simple matter to compare the performance of the active to the benchmark using the Sortino ratio. To illustrate the new technique, we compare the performance of exchange traded funds that track S&P equal-weighted and value weighed sector indexes.