Question

In the past, your boss assessed your performance based on the actual return on the portfolio of U.S. stocks that you manage. For each quarter in which your portfolio generated an annualized return of at least 20 percent, you received a bonus. Now your boss wants you to develop a method for measuring your performance from managing the portfolio. Offer a method that accurately measures your performance.

Answer 1

The method should be as shown below:

1. Identify a benchmark to measure your return. If your fund is sector or industry focused, the appropriate benchmark will be the index of that particular sector or industry. If you have a fully diversified, sector agnostic portfolio, then the market index can be used as the benchmark.
2. Define a new parameter called excess return, ER = Return of your portfolio - Return of the benchmark index
3. Link your performance to different levels of ER:

ER	Rating
0% - 5%	Average
> 5% - 10%	Good
> 10%	Outstanding

4. Your bonus can then be assigned based on your rating:

5. Rating	Bonus
   Average	20%
   Good	40%
   Outstanding	60%