What does M^2 measure in portfolio management?

M^2, or Modigliani-Modigliani Measure, is a risk-adjusted performance metric used in portfolio management. It essentially assesses how a portfolio would perform if it had the same risk as the market index, facilitating a direct comparison between a portfolio and a benchmark index.

The measure is calculated by adjusting the portfolio's return so that it is subjected to the same level of risk as that of the comparative market index. This allows for a clearer understanding of the portfolio's performance against the benchmark, considering variations in risk. By considering the risk-adjusted return, investors can gain insights into how much excess return is being generated for taking on additional risk compared to a market index.

In this context, the other options do not accurately describe M^2. While performance relative to a benchmark is a broader concept, it does not specifically capture the essence of M^2 as it pertains to adjusting for risk. Volatility, while an important factor in portfolio analysis, is not what M^2 measures directly. Lastly, liquidity pertains to the ease of converting assets into cash without significant loss of value, which is unrelated to the performance metrics M^2 addresses.