30 Questions
What does the allocation effect measure?
Manager's decision to over- or underweight a particular market segment
How is the allocation effect calculated?
[(Wpi - Wbi ) * (Rbi − Rb)]
What is good timing skill a matter of, according to the given text?
Investing more money in market segments producing greater-than-average returns
What does the selection effect measure?
Manager's ability to create specific market segment portfolios
How is the selection effect calculated?
[Rpi − Rbi ] * [Wpi - Wbi ]
What is the manager's total value-added performance according to the given text?
The sum of allocation and selection effects
Which factor is important for good timing skill, based on the text?
Market segment performance relative to benchmark return
What does the term 'Wpi - Wbi' represent in the allocation effect equation?
'Portfolio weight – Benchmark weight'
'Rpi − Rbi' in the selection effect equation represents:
'Portfolio return – Benchmark return'
'(Benchmark weight) * (Portfolio return – Benchmark return)' in the selection effect equation calculates:
'Selection Effect'
Which of the following is an essential attribute of a fund manager?
The ability to derive above-average returns for a given risk class
What is the main goal of superior security selection by a fund manager?
To find undervalued securities
What is the primary purpose of attribution analysis in performance measurement?
To determine the impact of market timing on portfolio returns
What differentiates allocation effects from selection effects in attribution analysis?
Allocation effects relate to changes in asset allocation, while selection effects relate to security choices
What is the significance of completely diversifying a portfolio relative to its benchmark portfolio?
It eliminates unsystematic risk
Which factor contributes to the actual return produced by a manager over an investment horizon?
The return that should have been earned given the capital commitment and the amount of risk in the portfolio
What can lead to superior risk-adjusted returns for a fund manager?
Superior timing and security selection
What are the two main considerations in performance management?
Risk-adjusted measures and attribution analysis
What is the desired attribute of a completely diversified portfolio in relation to its benchmark portfolio?
Perfectly correlated with the fully diversified benchmark portfolio
What contributes to deriving above-average returns for a given risk class as a fund manager?
The ability to diversify the portfolio completely to eliminate unsystematic risk
Which method does not contribute to evaluating expected returns?
Performance assessment
What are the limitations of peer group comparisons in evaluating expected returns?
Both a and b
What does portfolio drawdown measure?
How well the manager protected investors against losses
Which ratio measures risk premium per unit of risk?
Sharpe Ratio
What does Treynor Ratio measure?
Portfolio's return in excess of the risk-free rate per unit of beta
What does Information Ratio measure?
Average return in excess of a benchmark portfolio divided by the tracking error
What does Jensen Measure calculate?
How can risk-adjusted performance be computed relative to any multifactor model?
Through attribution analysis
What is the aim of Sharpe Ratio?
To measure risk premium per unit of risk
What is one limitation of peer group comparisons?
Difficulty in forming a large, meaningful group
Study Notes
- Investors evaluate expected returns using three methods: peer group comparisons, index returns, and risk factor models
- Performance assessment involves answering two questions: how did the portfolio manager perform, and what resources were used to achieve it
- Peer group comparisons use boxplots to display returns of a representative set of investors over a specific period, but they have limitations such as lack of adjustment for risk levels and difficulty in forming a large, meaningful group
- Portfolio drawdown measures how well the manager protected investors against losses, with maximum drawdown being the largest percentage decline in value from peak to trough
- Risk-adjusted performance measures include Sharpe Ratio, Treynor Ratio, and Information Ratio, which aim to measure a portfolio's total risk and performance relative to a benchmark
- Sharpe Ratio measures risk premium per unit of risk by subtracting the risk-free rate from the portfolio's return and dividing by the standard deviation of returns
- Treynor Ratio measures the portfolio's return in excess of the risk-free rate per unit of beta, indicating the slope of the fund's characteristic line and its position relative to the security market line
- Information Ratio measures a portfolio's average return in excess of a benchmark portfolio divided by the tracking error
- Jensen Measure, originally based on CAPM, calculates the difference between a portfolio's return and the return expected based on market conditions, with α indicating the manager's superiority or inferiority in investment ability.
- Risk-adjusted performance can be computed relative to any multifactor model, with attribution analysis decomposing the difference between a manager's total return and a benchmark policy portfolio into allocation and selection effects.
Test your understanding of performance management, risk-adjusted measures, attribution analysis, and desirable attributes of a fund manager. Calculate and interpret risk-adjusted performance measures and compare simple and risk-adjusted measures.
Make Your Own Quizzes and Flashcards
Convert your notes into interactive study material.
Get started for free
