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CFA Level III > Performance Evaluation > Flashcards

Flashcards in Performance Evaluation Deck (31):
1

Performance from Fund Sponor's Perspective

Performance shows the following:

  1. How effective IPS is
  2. Underperformance
  3. Results of active management

For feedback and control

2

Components of Performance Evaluation

  1. Performance measurement
  2. Performance attribution
    1. determines source of return
  3. Performance appraisal
    1. determine if its skill (should we fire a manager)

3

Return Calculation with Cash Flows

CF at beginning:

rt = EV - (BV + CF) / BV + CF

CF at end:

rt = (EV - CF) - BV0 / BV

4

TWR

Unaffected by external cash flows

Calculate returns subtracting cash flows then add together;

(1 + r)(1 + r)(1 +r) - 1

Example: 2.5M start, 2.7M end. 45K CF day 7, 25K CF day 19
Day 7 2.555M,  day 19 $2.575M

(2,555,000-45,000) - 2,500,000 / 2,500,000 = 0.4%
(2,575,000-25,000) - 2,555,000 / 2,555,000 = -0.2%
(2,700,000) - 2,575,000 / 2,575,000 = 4.9%
(1 + .004)(1 - .002)(1 + .049) - 1 = 5.1%

5

MWRR

EV = BV(1 + r)n + CF(1 + r)n

Just plug in figures for r

 

6

TWRR vs. MWRR

TWR
+ unaffected by timing of cash flows
+ required for GIPS
- need to know valuations on each CF date

MWR
 + good if manager controls CF
- distorted by size and timing of CF
 

7

TWR vs MWRR

Which is better?

Cash       Prior to _____ Performance     Result

None                  None                                 Same

+CF                   Strong                              MW > TW

+CF                   Weak                               TW > MW

-CF                    Strong                             TW > MW

-CF                   Weak                                MW > TW

8

Data Quality for Returns

  • Stale price:
    • Illiquid assets - use estimates
    • Fixed income - use matrix
  • Should include accrued interest and dividends
  • Use trade date

9

Portfolio Return Components

P = Market + Style + Active

M = market return, Style = B - M, Active = P - B

Client responsible for S
Manager responsible for A

Example: LC Value Fund earns 18.9% for 3 quarters
Russell 1000 Value = 21.7%, Wilshire 5000 = 25.2%

Style = 21.7 - 25.2 = -3.5%
Active = 18.9 - 21.7 = -2.8%

10

Valid Benchmark

SAMURAI

  • Specified in advance
  • Appropriate
  • Measurable
  • Unambiguous (Clear/Precise)
  • Reflective of manager's current investment opinons
  • Accountable
  • Investable

11

Types of Benchmarks

  1. Absolute return: i.e. 5%
    1. Drawback: NOT investable
  2. Peer group
    1. Drawback: subject to survivor bias, NOT investable
    2. Fails every quality test EXCEPT measurable
  3. Broad market index
    1. Drawback: manager style may deviate
  4. Style index
    1. Drawback: different definitions of style
  5. Factor-based models
  6. Return-based
  7. Custom

12

Testing Benchmark Quality

  1. Mutually exclusive with indices/asset classes
  2. Exhaustive of manager's investment universe
  3. Represent distinct sources of risk

13

Hedge Fund Benchmarks

Hard to assign a benchmark. Use:

  1. Value-added return for each position
  2. Separate long/short benchmarks
  3.  sharpe ratio often used but not appropriate
  4. Market neutral should be Rf

14

Macro Attribution Analysis Levels

Beginning Value

  1. Net contribution
  2. Rf
  3. Asset categories (pure indexing SAA from IPS)
  4. Benchmarks (pure indexing TAA from manager)
  5. Investment managers (active management)
  6. Allocation effects (error/plug number)
    Ending Value

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15

Micro Attribution Components

Pure Sector Allocation

Definition: Sector deviation from benchmark

Formula: 

(Wp,s - Wb,s) * (Rb,s - Rb)

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16

Macro Attribution

Formulas

Asset Category: weight(B - Rf)

Style/Misfit: weight * weight * (misfit return)

Investment Manager: weight * weight * (true active return)

 

17

Micro Attribution Components

Within-sector Selection

Definition: Security selection deviation from benchmark

Formula: 

(Wb,s) * [(Rp,s - Rb,s)]

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18

Micro Attribution Components

Allocation/Selection Interaction

Definition: Sector deviation from benchmark

Formula: 

(Wp,s - Wb,s) * (Rp,s - Rb,s)

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19

All Micro Attribution Components

Pure Sector Allocation: (Wp,s - Wb,s) * (Rb,s - Rb)

Within sector selection: (Wb,s) * [(Rp,s - Rb,s)]

Allocation/Selection Interaction: (Wp,s - Wb,s) * (Rp,s - Rb,s)

20

Fundamental Factor Models for Micro Attribution

Regress historical returns vs factors. Help identify:

  • source of portfolio returns
  • sector rotation
  • ability to time market

      + considers other factors   + insight to investment style
      - complex

21

Fixed Income Attribution Details

External Interest Rate Effect

  1. Just the benchmark
  2. Not under manager's control
  3. Expected: simulated return on default-free benchmark
  4. Unexpected: return based on actual price changes

*This is what was earned passively*

22

Fixed Income Attribution Details

Manager Attribution

  1. Interest rate management
    1. Duration, convexity, YC shape change
  2. Sector/quality management - weighting of sectors/quality
  3. Security-selection - effect on held securities
  4. Trading - plug figure (error/unknown)

*Must sum up to actual portfolio return*

23

5 Types of Risk-Adjusted Measures

1. Jensen Alpha: Rp - CAPM      [Rf + B(Rm - Rf)]

2. Treynor: (R- Rf)  /  Bp

3. Sharpe: (RP - Rf)  / stdp

4. M2: Rf + [(Rp - Rf / stdp) * stdm]

5. IR: active return / active risk

24

Jesen Ex post Alpha

Rp - [Rf + B(Rm - Rf)]

 

  • Cosiders only systematic risk (beta)
  • Good for actively managed portfolios

25

Treynor

(Rp - Rf)  /  Bp

 

  • Measures return over systematic risk (beta)
  • Used to evaluate additions to portfolios

 

26

Sharpe Ratio

(R- Rf) / stdp

 

  • Excess return relative to total risk
  • Assumes returns are normally distributed

27

M2 Measure

RF + [(RP - RF / stdp) * stdm]

             ^ Sharpe ratio

  • Value added/lost if portfolio had same std as market
  • Based on total risk

28

Information Ratio

active return / active risk

RP - RB / [stdp - stdB]

29

Quality Control Charts

  • Presents manager performance over time
  • Value added = 0    then goes above/below
  • Over time acceptance range narrows

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30

Quality Control Charts Errors

  • Type I - retaining poor manager
  • Type 2 = firing superior manager

31

Manager Continuation Policies

  • Costly to hire/fire managers
    • New managers will make changes adding costs
  • Goals are to:
    • Retain best managers
    • Base decision off of more than just performance
    • Apply consistent procedures