Does the Use of Downside Risk-Adjusted Measures Impact the Performance of UK Investment Trusts?

Abstract

This paper investigates the impact of using different risk-adjusted measures of performance on the evaluation of UK investment trusts. Significant negative skewness is probably the most important empirical property of the time series of returns under analysis. Performance results based on the Sharpe Ratio and several downside risk-adjusted performance measures (the Sortino ratio, excess return on Cornish-Fisher VaR, excess return on VaR, and excess return on Expected Shortfall) are compared. VaR and Expected Shortfall are computed using Filtered Historical Simulation (FHS), a hybrid methodology that combines the use of volatility models with bootstrapping techniques and is robust to the empirical characteristics of our data. Four alternative measures, both parametric and non-parametric, are applied in order to assess the level of association between different performance measures. The Pearson correlation coefficient is applied in the context of the parametric approach. Additionally, two alternative non-parametric measures of rank correlation are used: Spearman´s coefficient and Kendall´s Tau. As an alternative to these rank correlation analysis, Cohen´s Kappa, a non-parametric measure based on contingency table statistics is also computed. The observed level of association between Sharpe Ratio and the downside risk-adjusted measures of performance is not as low as would be expected considering the empirical properties of our data. However, an additional analysis based on a simulated sample of returns, with a higher variability in the skewness and the kurtosis of the time series, demonstrates that the choice of the performance measure does indeed have an impact on the performance assessment of investment portfolios. With respect to the simulated time series of returns considerable lower levels of association are reported especially with the application of Cohen´s Kappa statistic.