CFA III - Performance Measureement

Performance Measurement definition

calculate return and risk of fund and compare with benchmark

Performance attribution definition

determine key drivers that generated performance

Performance appraisal definition

Interpret performance attribution, luck or skill?

The definition of effective performance attribution includes (4 things)

Reflect 100% of the portfolio's return and risk; decision-making process; Active investment decisions made; Full explanation of portfolio excess return and risk

Return attribution definition

Impact of active portfolio management decisions on returns

Risk attribution definition

Impact of manager’s active investment decisions on portfolio risk

Macro attribution definition

quantifying decisions at fund sponsor’s level

micro attribution definition

quantifying decisions at the portfolio manager’s level

Return attribution type - return-based. - characteristics

regress market against portfolio return, best alternative to holding based

Return attribution type - holdings-based - characteristics

doesn’t adjust for portfolio changes, best for passive funds with little turn-over, accuracy improved with shorter intervals

Return attribution type - transaction-based - characteristics

Updates for portfolio changes, but complicated and time consuming

Which of the three return attribution is the easiest?

return-based

Which of the three return attribution is the most reliable? Rank from most to least

transaction, holding, return

Which of the three return attribution is the slowest at detecting style drift?

return-based

The return attribution model name that separates portfolio return in three components?

BHB Model

what does allocation effect tell you?

Choice to overweight or underweight sectors

What does BF model address

BHB method drawback that the sign of the allocation effect doesn’t reflect true correctness

Market factor of the Carhart Model Calculates

return on a value-weighted equity index above that of the one-month T-bill rate

Size factor of the Carhart Model Calculates

average return on three small-cap portfolios - the average return on three large-cap portfolios

Value factor of the Carhart Model Calculates

the average return on two high-book-to-market portfolios - the average return on two low-book-to-market portfolios

which type of return attribution is best for hedge funds

return-based

What’s the reason of using geomtric return attribution over arithmetic

better for multiperiod attribution, no need for smoothing

Momentum factor of the Carhart Model Calculates

past year winners - past year losers

Fixed-Income Return Attribution: Exposure decomposition - duration

Segment portfolio by their market value weight and assign securities to duration buckets

Fixed-Income Return Attribution: Yield Curve Decomposition - duration

use duration and YTM in computing price return and decompose factor drivers

Fixed-Income Return Attribution: Yield Curve Decomposition - full repricing

Reprice securities based on spot rates

Components of exposure decomposition

interest rate allocation (duration effect + curve effect), sector allocation, bond selection

Components of yield curve decomposition (8)

yield, roll, shift, slope, curvature, spread, specific, residual

spot rates are the same as

zero coupon curves

which Fixed-Income Return Attribution provides the most accurate measure of price return?

yield curve repricing

relative risk attribution analysis use __ measure for risk

tracking error

absolute risk attribution analysis use __ measure for risk

standard deviation

macro risk attribution looks at __ level

sector and asset classes

micro risk attribution looks at ___ level

individual security

factor-based relative risk attribution

factor marginal contribution to tracking error and active specific risk

factor-based/top down absolute risk attribution

actor’s marginal contribution to total risk and specific risk

From macro to micro risk attribution

from specific assets weights to micro active management decisions

Liability-Based Benchmarking can use

nominal bonds, inflation-adjusted bonds, and lower volatility stocks

Asset-Based Benchmarks: Absolute

exceed minimum target return

Broad market indexes drawback?

Might not be relevant if manager style drift

Describe return-based benchmark

weighted average of that asset class index that best explains portfolio return

which of the two asset based benchmark often fail the properties of valid benchmark?

absolute and manager universe

which of the two asset based benchmark use regression analysis?

return-based and custom security based

Name the properties of a valid benchmark (SAMURA)?

specified in advance, appropriate, measurable, Unambiguous, Reflective of current investment opinions, Accountable, Investable

Name the three benchmark for hedge funds

broad market, risk free rate, peer universe

disadvantages of using broad market as benchmark for hedge funds

not appropriate given wide range of hedge fund investment

disadvantages of using risk-free rate as benchmark for hedge funds

doesn’t reflect systematic risk and leverage

disadvantages of using peer group as benchmark for hedge funds

group risk and return objectives probably won’t match

why is it difficult to find benchmark for real estate?

can have sampling bias, subjected to smoothing, inconsistency in leverage, index biased to larger investments, index assumptions not realistic in transaction costs and liquidity

private equity benchmark and drawback?

IRR, difficult comparability

Commodity benchmark and drawback?

Futures, difficult comparability

Managed derivatives benchmark and drawback?

lack of indexes, can be too specific or too broad

Distressed securities benchmark and drawback?

almost impossible, too illiquid and lack of marketability

Drawback of sharpe ratio

denominator doesn’t differentiate good and bad volatility, unfairly inflate volatility

drawback of Treynor ratio

only considers systematic risk rather than total risk, can only be used for efficient markets and well-diversified portfolios

Systematic risk

Nondiversifiable risk, non-company specific risk, beta

Treynor ratio is goodd for comparing

two well-diversified portfolios

Advantage of information ratio

accounts for the difference in risk between portfolio and the benchmark

the standard deviation of the difference between portfolio and benchmark returns is also known as

tracking risk

The denominator of the Sortino ratio is also known as

Semideviation

Advantage of Sortino ratio

provide more meaningful view of a portfolio’s risk-adjusted return than the Sharpe ratio since it only considers the standard deviation of the downside risk

Disadvantage of Sortino Ratio

Not very comparable since not all managers have the same MAR

Greater upside capture also called

positive asymmetrical

Drawdown duration is

The total time required to fully recover a drawdown

Maximum drawdown

point at which the cumulative drawdown is at its highest

why do investors look at drawdown evaluation?

To look for duration and max drawdown, not to compare returns or risk

DB vs. DC, which one is the one with specific and explicit liabilities

DB

Manager universe should consist of those who (list 3)

Suitable for the objectives and constraints of IPS, relevant style, proper balance between active and passive

quantitative analysis of investment manager universe

Evaluation through performance attribution and appraisal

what type of style of return analysis is the most appropriate for quantitative analysis

holdings based

qualitative analysis of investment manager universe

Likelihood of same level of returns continuing the future, relevant risk?

Null hypothesis of investment manager selection

manager adds no value

alternative hypothesis of investment manager selection

manager adds positive value

Type I error of investment manager selection

keeping managers who are not adding value

Type II error of investment manager selection

Firing good managers who are adding value

If significance level decrease/confidence level increase, Type I error will___, Type II error will___

reduce, increase

Which error is psychologically more painful, type I or type II?

type I

Type I error has __ cost, Type II error has_cost (chose between explict/implicit)

explicit, implicit

More efficient funds have (higher/lower) type I and (high/lower) type II errors?

lower, lower

long-only funds tend to be more ___ than alternatives and private equity market funds

efficient

The greater the difference between strong and weak manager’s sample size and mean, the ___ the cost of Type I and Type II errors

greater, since opportunity cost of hiring and retaining unskilled manager is high

The wider the dispersion of returns between strong and weak managers, the ___ thee cost of Type I and Type II errors

lower, easier to distinguish

definition of style analysis

Examine the manager’s risk exposures to benchmarks and changes in benchmarks

Return-based style analysis (RBSA)

Estimates the portfolio sensitivities to security market indexes for a set of key risk factors, top-down, easier computation and can be produced timely, use regression, can bee imprecise

Holdings-based style analysis (HBSA)

Bottom-up, look at actual securities, more complex and may not be useful for projections

When is it hard to use holding-based style analysis (HBSA)?

When portfolio has high turnover

Type I error is ___ to measure, type II error is ___to measure

easy, hard

For illiquid assets, which one is better, Return based RBSA or holdings based HBSA?

both will be similarity inaccurate

What does capture ratio analysis tell you?

Look at whether asymmetry is natural or due to manager skill

What does drawdown analysis tell you?

identity poor strategies, weak internal controls, and operational problems

What does an portfolio with smaller and less extended drawdowns tell you?

investor may have shorter time horizon and low risk tolerance

Investment philosophy definition

 How a manager attempt to exploit inefficiencies to generate excess returns

Passive investment philosophy

earn risk premium, bear systematic risk only

Active investment philosophy

exploit inefficiency, bear unsystematic risk

Behavior inefficiencies are ___ term

short

Structural inefficiencies are ___ term

long term if due to laws and regulations

Ability to exploit inefficiencies also include

if there’s enough assets to exploit, and whether returns will exceed the extra transaction and borrowing cost

Groupthink behavior bias

Team together have one consensus leading to confirmation bias

Authority bias behavior bias

Deferring decisions that are experts or in authority

Aversion to complexity behavior bias

Too much attention is given to small issues