Risk Adjusted Performance Measures in a Property Finance Business in South Africa
Date
2012-10-04
Authors
Tichareva, Michael Tangenhamo
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Abstract
The purpose of this research is to analyse risk adjusted performance measures in a South African Property Finance Business. This is performed through the application of the Treynor, Sharpe and Jensen measures, which are risk adjusted performance measures in finance, to banking. Conclusions are drawn on whether risk adjusted performance measures lead to materially different results on ranking of performance when compared with traditional measures such as return on equity and return on assets. The research also discusses the strategic decisions that would result from using risk adjusted performance measures. The study contrasts risk adjusted performance measures with non-risk adjusted traditional performance measures in a Property Finance business within the banking sector in South Africa. The problem statement for the research was, therefore, stated as follows: To determine if the use of risk adjusted performance measures in a South African Property Finance Business leads to different strategic decisions by bank executives. Following a literature review, the research proposes that risk adjusted performance measures when compared with traditional non-risk based performance measures such as return on equity and return on assets, lead to different results on performance ranking of business units or activities within a business unit. Both quantitative and qualitative approaches to research are undertaken. We chose Nedbank Corporate Property Finance as a case study because of the simplicity for the researcher to access financial data for the quantitative part of the research and interviewees for the qualitative part of the research.
The key findings in this research are that there are differences in performance rankings between traditional measures of performance and risk adjusted measures. Business activities that perform better on non-risk adjusted basis are not necessarily the best performing on a risk adjusted basis. Hypothesis testing also show that the differences in performance rankings are material. We, therefore, conclude that there is significant change in performance rankings after adjusting returns for risk suggesting that the risk adjusted measures of performance lead to materially different strategic decisions on capital allocation and investment or disinvestment from a business activity compared with the non-risk adjusted performance measures. The study provides guidance to executives in banking and the financial services industry at large. The key message is, therefore, that banking executives must pay particular attention to risk adjusted performance measures in making strategic decisions such as pricing, capital allocation, investment and disinvestment from business activities. Risk adjusted performance measures have been found to be superior to the traditional measures, leading to optimal strategic decisions. Executives should implement sustainable risk based performance measurement systems that are built on a strong governance and risk management culture for the whole organisation. Apart from banking, executives in the financial services industry in general should focus on risk adjusted performance measures when making strategic decisions affecting the performance of their financial institutions. Shareholders also need to start asking critical questions about the performance of their investments relative to the risks taken by the executives. Very often, prospective and current shareholders look at return on equity and return on asset performance measures without paying particular attention to the risks associated with a particular investment. On a risk adjusted basis, businesses that perform better should, ideally, receive greater attention and be allocated more capital.
Description
MBA thesis - WBS
Keywords
Risk, Property financing, Business risk