Risk, Return, and Performance Measurement: A Case of Unrealistic Expectations?


  • This article stems from my executive internship experience and data initially provided as of Summer 1994.


Client criteria imposed upon active asset management companies to hold only high-quality (HQ) investments in achieving specific Treasury-adjusted spreads and above-average rates of return effectively mandate a passive management policy and can be met only with very low probability. HQ investments do not consistently outperform either medium (MQ) or low quality (LQ) investments over time regardless of whether returns are measured monthly, quarterly, or yearly. Further, both time series and cross-sectional results show that HQ sectors are generally associated with ex post returns that are lower than those for either MQ or LQ sectors. Finally, HQ sectors do not outperform MQ and LQ sectors in consistently surpassing Treasury spreads or crediting rates. These results suggest that periodic evaluation of asset performance in light of such stringent criteria misunderstands the dynamic nature of the market as well as fundamental risk/return relationships.