Section 5 - R26 - Portfolio Performance Evaluation

Question 1

Performance Measure (Concept)

Answer 1

How was the portfolio’s performance?
- Absolute performance
- In excess over a benchmark return

Question 2

Performance Attribution (Concept)

Answer 2

How was the portfolio performance achieved?
- Explain
- What portion was due to active manager decisions
- Decompose excess return and risk

Question 3

Performance Appraisal (Concept)

Answer 3

Was the performance achieved through manager skill or luck?

It assesses the quality of a portfolio performance

Question 4

Question: An EFFECTIVE performance attribution must… (List)

Answer 4

1. Account for all of the portfolio’s risk and return
2. Reflect the investment decision-making process
3. Quantify the active decisions of the portfolio manager
4. Provide a complete understanding of the excess risk / return

Question 5

Performance Attribution Aspects in terms of Risk and Return (Explain)

Answer 5

1. Return Attribution: Impact of active investment decisions on returns
2. Risk Attribution: Analyzes the risk consequences of those decisions

Question 6

Types of Performance Attribution (List and Explain)

Answer 6

1. Returns Based: Easy. Uses Portfolio’s Total Return (over a period) + Identifies its sources.
2. Holdings Based: Beggining of Period Holdings. All transactions assumed to occur at end of day. Accuracy improves when data has shorter intervals.
3. Transactions Based: Holdings + Transactions -> Accurate trade results

Question 7

a. Returns Based Attribution (Detail)

Answer 7

• Uses Total Portfolio Return
• Appropriate when underlying holdings information is not available
• Easy to implement
• Least Accurate
• Most vulnerable to data manipulation

Question 8

b. Holdings Based Return (Detail)

Answer 8

• References beginning of period portfolio
• Fails to capture transaction data
• Most appropriate if turnover is low

Question 9

c. Transactions Based Return (Detail)

Answer 9

• Uses both Holdings + Transactions info during specified period
• Most accurate, most difficult and time consuming to implement

Question 10

Micro Attribution (Concept)

Answer 10

Drivers do retorno do manager + se estão consistentes com o processo de investimento

Question 11

Macro Attribution (Concept)

Answer 11

Asset Owner’s tactical asset allocation and manager selection

+ Effect of the manager selection and timing decisions

(Vontade do dono em fugir do plano estratégico / SAA)

Question 12

(a) Equity Attribution Measurement Approaches

Answer 12

1. Brinson Hood Beebower (BHB):
2. Brinson-Fachler (BF):

• Diferença: Alocação
• BF considers (ΔPw-Bw)*(rb-Rb)
• Exemplo: no BF, se eu over-aloquei em algo que performou mal, mas MENOS MAL que o benchmark, meu “valor adicionado” será positivo.

Question 13

Differentiate BHB e BF

Answer 13

BHB: Allocation from an absolute (+) or (-) perspective

BF: Allocation from a relative perspective versus a total benchmark return

Question 14

(b) Factor-Based Models (Concept)

Answer 14

• Decompose contributions to excess returns from factors

Carhart:
(Rp-Rf) = + b1RMRF + b2SMB + b3HML + b4WML + Erro

Question 15

(c) Fixed Income Attribution Approaches (List)

Answer 15

1. Exposure Decomposition: Top down. Compare various items against benchmark (duration, yield curve, sectors, active decisions).
2. Yield Curve Decomposition: Duration based. Estimate impacts of ΔYield in Portfolio v. ΔYields impact in Benchmark

a. Calculate Total Return = % Income + % Price Change
Price Change = -ModDur*ΔYield
b. Difference = Effect of Active PM decisions
c. Yield Curve Decomposition

3. Yield Curve Decomposition: Full Repricing

Question 16

(c.1) Fixed Income: Exposure Decomposition (Describe)

Answer 16

Top down approach. Explain active management through a hierarchy of decisions from the top to the bottom.

Question 17

(c.2) Fixed Income: Yield Curve Decomposition (Duration Based)

Answer 17

Duration based. Top-down or bottom up.

a. Calculate Total Return = % Income + % Price Change
Price Change = -ModDur*ΔYield
b. Difference = Effect of Active PM decisions
c. Yield Curve Decomposition

Question 18

(c.3) Fixed Income: Yield Curve Decomposition (Full Repricing)

Answer 18

1. Reprecifies all securities given ΔYield that actually happened (instead of estimates)
2. Measure impact of those changes in portfolio’s returns

Note: Most complex

Question 19

Risk Attribution

Answer 19

a. Absolute Mandates: identifies sources of volatility

b. Benchmark Relative: Identifies sources of tracking risk

Question 20

Investment Decision Making Process: BOTTOM UP

Answer 20

BOTTOM UP: Contribuição Marginal, sempre

a. RELATIVE: p/ o Tracking Risk (Desvio do Benchmark)

b. ABSOLUTE: p/ o Total Risk

Question 21

Investment Decision Making Process: TOP DOWN

Answer 21

Top Down: Attribute tracking risk to relative allocation and selection decision

Question 22

Investment Decision Making Process: FACTORS BASED

Answer 22

Factors marginal contribution to (a) tipo de risco e (b) tipo de risco específico

RELATIVE: Tracking Risk + “ACTIVE” Specific Risk

ABSOLUTE: Total Risk + Specific Risk (não idiossincrático)

Question 23

Macro Attribution: Sponsor Level (List)

Answer 23

Decision 1: Deviations from the SAA

Decision 2: Selection of investment managers

Question 24

Tracking Risk (Concept)

Answer 24

Risco em relação ao benchmark. Relativo.

Question 25

Specific Risk (Concept)

Answer 25

Risco idiossincrático do portfolio (único)

Question 26

Active Specific Risk (Concept)

Answer 26

Subset do specific risk relativo a risco ativo de decisões do benchmark

Question 27

Benchmarks (Concept)

Answer 27

Collection of securities that represents assets available to the PM.

Question 28

Market Index Benchmark (Concept)

Answer 28

Benchmark that represents the performance of a specific security market, market segment or an asset class.

Question 29

Liability Based Index Benchmark (Concept)

Answer 29

Benchmark focused in the cashflows that an asset must generate

Question 30

Valid Benchmark Properties (List)

Answer 30

- Unambiguous (Securities/Weights Clearly Identified) - Investable (Replicable) - Measurable (On frequent / timely basis) - Appropriate (Consistent with PM's Style) - Reflective of Current Investment Opinions - Specified in Advance - Accountable (Manager should accept it)

Question 31

Asset Based Benchmark Types (List)

Answer 31

- Absolute Benchmark Return - Broad Market Indexes - Style Indexes - Factor Based Model Benchmarks - Returns Based (Regressão) - Manager Universe (Peer) - Customs Security Based

Question 32

Absolute Benchmark Return (Concept)

Answer 32

Ex: 5% de retorno anual Cons: - Not investable

Question 33

Broad Market Indexes (Concept)

Answer 33

Ex: S&P 500 Pros: Easy recognition, understandable, widely available Cons: Inappropriate if PM deviates

Question 34

Style Indexes (Concept)

Answer 34

Ex: Value S&P 500 Pros: Often well known, easy to understand, widely available

Question 35

Factor Based Model Benchmarks (Concept)

Answer 35

- Ambiguous - Not specified in advance - May not be investable

Question 36

Benchmark Quality (Formula)

Answer 36

(i) P = B + A (ii) P = M + (B-M) + A (iii) P = M + S + A P = Portfolio B = Benchmark A = Active Decisions = (P-B) B = Market + Style (B-M) S = Style = (B-M)

Question 37

Challenges: Benchmark Alternative Investments (List)

Answer 37

- Lack of investable market indexes - Usage of Leverage - Limited Liquidity - Lack of readily available market values

Question 38

Benchmark to Hedge Funds (List)

Answer 38

- Broad indexes not suitable - Rf + Spread is sometimes used - Fund Manager Universe may be used Cons: - Risk and return of benchmark not representative - Survivorship and backfill bias - HF performance is self reported

Question 39

Real Estate Benchmark (List)

Answer 39

- Numerous indexes Cons: - Not representative - Subsets of asset class - Returns and values are smooth / based in appraisal data - Performance correlated with largest assets - Lag

Question 39

Private Equity Benchmark (List)

Answer 39

Mostly peer group benchmarks Cons: - Valuation - Funds IRR depends a lot on timing of cashflows

Question 40

Commodity Investments Benchmark (List)

Answer 40

- Indexes based in futures - Vary greatly in composition and weight - Actual funds use leverage

Question 41

Managed Derivatives Benchmark (List)

Answer 41

- Specific to a single investment strategy

Question 42

Distressed Securities (List)

Answer 42

- Illiquid - Hard to construct an index

Question 43

True Active Return (Formula)

Answer 43

True Active Return = P - Normal Portfolio P = Portfolio Manager Return

Question 44

Misfit Active Return (Formula)

Answer 44

Misfit Active Return = (P - Investor Benchmark) Investor Benchmark = Named in SAA

Question 45

Appraisal Measures (List)

Answer 45

1. Sharpe 2. Sortino 3. Treynor

Question 46

Sharpe Ratio (Formula)

Answer 46

Sharpe = (Rp - Rf)/σ portfolio

Question 47

Treynor Ratio (Formula)

Answer 47

Treynor = (Rp - Rf)/β Uses systematic risk. For well diversified portfolios.

Question 48

Information Ratio (Formula)

Answer 48

IR = (Rp - Rbenchmark) / σativo IR = Ractive / σativo

Question 49

Appraisal Ratio (Formula)

Answer 49

AR = α / σe α = alpha = b0 da regressão = intercepto σe = desvio-padrão do resíduo

Question 50

Sortino Ratio (Formula)

Answer 50

Sortino = Rp-Rt / σd Rt = Target Return σd = Semi Deviation = Std Deviation of Downside Risk

Question 51

Sortino Ratio Usage (List)

Answer 51

- Better for Hedge Funds and Commodity Trading - Usage of Semi Deviation (only downside risk)

Question 52

Capture Ratios (Concept & Formula)

Answer 52

Capture Ratio = UC / DC If > 1 é positive / convex If < 1 é negative / concave UC = Rportfolio / R bench DC = Rportfolio / R bench sendo, UC = Upside Capture if Rbench > 0 DC = Downside Capture if Rbench < 0 Mede assimetria da captura do upside em relação ao downside