Portfolio performance depends crucially on the behaviour of returns on the assets held in the portfolio. However, there is some misunderstanding in practice about the econometric relationships involved.
In particular, the distinction between annual (arithmetic) returns and compound (geometric) returns is not well understood, both in respect of individual asset classes and in respect of portfolios.
These issues were summarised in the following article I published in The Actuary:
- McCulloch, Brian W. Expected Geometric Return and Portfolio Analysis. The Actuary (March 2004) pp. 30-31. [Download: Actuary Article]
… and explored in more detail in a Treasury Working Paper:
- McCulloch, Brian W., Geometric Return and Portfolio Analysis (December, 2003). New Zealand Treasury Working Paper 03-28. [Download: twp03-28]