Performance Evaluation

Question 1

Performance from Fund Sponor’s Perspective

Answer 1

Performance shows the following:

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

For feedback and control

Question 2

Components of Performance Evaluation

Answer 2

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

Question 3

Return Calculation with Cash Flows

Answer 3

CF at beginning:

r_t = EV - (BV + CF) / BV + CF

CF at end:

r_t = (EV - CF) - BV₀ / BV

Question 4

TWR

Answer 4

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%

Question 5

MWRR

Answer 5

EV = BV(1 + r)ⁿ + CF(1 + r)ⁿ

Just plug in figures for r

Question 6

TWRR vs. MWRR

Answer 6

• *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

Question 7

TWR vs MWRR

Which is better?

Answer 7

Cash Prior to _____ Performance Result

None None Same

+CF Strong MW > TW

+CF Weak TW > MW

• CF Strong TW > MW
• CF Weak MW > TW

Question 8

Data Quality for Returns

Answer 8

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

Question 9

Portfolio Return Components

Answer 9

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%

Question 10

Valid Benchmark

Answer 10

SAMURAI

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

Question 11

Types of Benchmarks

Answer 11

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

Question 12

Testing Benchmark Quality

Answer 12

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

Question 13

Hedge Fund Benchmarks

Answer 13

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 R_f

Question 14

Macro Attribution Analysis Levels

Answer 14

Beginning Value

1. Net contribution
2. R_f
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**

Question 15

Micro Attribution Components

Pure Sector Allocation

Answer 15

Definition: Sector deviation from benchmark

Formula:

(W_p,s - W_b,s) * (R_b,s - R_b)

Question 16

Macro Attribution

Formulas

Answer 16

Asset Category: weight(B - R_f)

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

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

Question 17

Micro Attribution Components

Within-sector Selection

Answer 17

Definition: Security selection deviation from benchmark

Formula:

(W_b,s) * [(R_p,s - R_b,s)]

Question 18

Micro Attribution Components

Allocation/Selection Interaction

Answer 18

Definition: Sector deviation from benchmark

Formula:

(W_p,s - W_b,s) * (R_p,s - R_b,s)

Question 19

All Micro Attribution Components

Answer 19

Pure Sector Allocation: (W_p,s - W_b,s) * (R_b,s - R_b)

Within sector selection: (W_b,s) * [(R_p,s - R_b,s)]

Allocation/Selection Interaction: (W_p,s - W_b,s) * (R_p,s - R_b,s)

Question 20

Fundamental Factor Models for Micro Attribution

Answer 20

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

Question 21

Fixed Income Attribution Details

External Interest Rate Effect

Answer 21

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*

Question 22

Fixed Income Attribution Details

Manager Attribution

Answer 22

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*

Question 23

5 Types of Risk-Adjusted Measures

Answer 23

1. Jensen Alpha: R_p - CAPM [R_f + B(R_m - R_f)]
2. Treynor: (R_p - R_f) / B_p
3. Sharpe: (R_P - R_f) / std_p
4. M²: R_f + [(R_p - R_f / std_p) * std_m]
5. IR: active return / active risk

Question 24

Jesen Ex post Alpha

Answer 24

R_p - [R_f + B(R_m - R_f)]

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

Question 25

Treynor

Answer 25

**(R_p - R_f) / B_p** * Measures return over systematic risk (beta) * Used to evaluate additions to portfolios

Question 26

Sharpe Ratio

Answer 26

**(R_P - R_f) / std_p** * Excess return relative to **total risk** * Assumes returns are normally distributed

Question 27

M² Measure

Answer 27

R_F + [**(R_P - R_F / std_p)** \* std_m] **^** Sharpe ratio * Value added/lost if portfolio had same std as market * Based on **total risk**

Question 28

Information Ratio

Answer 28

active return / active risk R_P - R_B / [std_p - std_B]

Question 29

Quality Control Charts

Answer 29

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

Question 30

Quality Control Charts Errors

Answer 30

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

Question 31

Manager Continuation Policies

Answer 31

* 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