. Portfolio management can be the most brutal of professions because the only one objective is to make money and because markets are the harshest of performance evaluators, providing feedback (often instantaneous) on decisions. The fact that a decision is well researched and backed up by great reasons does not provide a guarantee or even great odds of success. Conversely, the rashest and least rational of investment decisions may yield great returns for a lucky investor.

In evaluating the performance of a portfolio manager, there are three questions that have to be answered. The first question relates to how much risk the portfolio manager took on in creating the portfolio for the investor. This question requires an adherence to a model of risk and return that quantifies the risk; in finance, the models in use tend to emphasize statistical measures of risk, based upon historical data, that measure the risk added on by an investment to a diversified portfolio. The second question relates to what return the portfolio manager earned over the period for the investor. While this may seem straightforward, it can be complicated by cash inflows and outflows that occur over the period. The final question relates to the return the portfolio manager should have made over the period, given the risk taken on and given what markets earned over the same period; this is called the conditional expected return. The comparison of the actual returns to the conditional expected return provides a measure of the success of the portfolio manager; actual returns that exceed expected returns indicate that the manager outperformed the market, while actual returns that are lower indicate that it under performed.

Given the importance of performance evaluation to the profession, it should not be surprising that none of these measurements are free of controversy. In measuring risk, the question of which risk and return model to use is contentious, especially since performance numbers and rankings can be affected significantly by changing the model. In measuring expected returns, the choice of a benchmark becomes an issue since different benchmarks yield different results. Portfolio managers, in their zeal to outperform the markets, try to out guess the performance evaluators, and take actions that might make their performance look better at the expense of after-tax returns.

Portfolio managers often complain that they find the frequency of performance evaluations distracting, and that performance evaluations penalize them for following strategies that provide long term returns. This might be true, but it is unlikely that investors will be willing to leave their money with a portfolio manager and trust the manager to do a good job. Conversely, as portfolio managers earn investor trust, by delivering superior returns, they are much more likely to come under pressure to deliver immediate returns.