Question

You collected the information below regarding two portfolios: Portfolio X and Portfolio Z. You will invest in only one of these portfolios. The portfolio you will select will be your entire investment (that means your overall investment portfolio). You want to select the portfolio that is performing better. Which portfolio would you select? How did you select it?

Market risk premium: 1.63

Information on Portfolio X

Portfolio X risk premium: 0.358

Portfolio X total risk: 0.133

Security Characteristic Line Regression Statistics for Portfolio X

Alpha: 1.63

Beta: 1.20

Information Ratio: 5.11

R-squared: 0.91

Information on Portfolio Z

Portfolio Z risk premium: 0.276

Portfolio Z total risk: 0.126

Security Characteristic Line Regression Statistics for Portfolio Z

Alpha: 5.28

Beta: 0.80

Information Ratio: 5.52

R-squared: 0.64

Answer 1

We would select portfolio Z. The reasons for this selection are given below:

1. The beta of portfolio Z is only 0.8 which is also lower than that of portfolio X. A lower beta implies lower risk.
2. The Alpha of portfolio Z is 5.28 which is higher than that of portfolio X. Since Alpha is a measure of excess returns that the portfolio provides over market returns, the portfolio Z is better than X in terms of return as well.
3. Information ratio is also higher in the case of portfolio Z as compared to portfolio X. This implies that portfolio Z is giving higher active return per unit risk than portfolio X.