11 The performance of investments

Question 1

Past performance data is essential for:

Answer 1

1. Understanding markets
2. Assessing/rewarding managers
3. Charging performance-related fees

Question 2

What does performance evaluation determine?

Answer 2

1. Did the investment manager add value?
2. How did they achieve the calculated return?

Question 3

How is holding period return expressed?

Answer 3

% of the initial investment

Question 4

What does MWR measure?

Answer 4

Overall return over a specific period

Question 5

What does TWR measure?

Answer 5

Relative performance of different managers

Question 6

MWR can also refer to…

Answer 6

Internal rate of return (IRR)

Question 7

What is the equation for holding period return?

Answer 7

R = (V₁ + D - V₀) / V₀

Question 8

What is the equation for money weighted return?

Answer 8

MWR = (V₁ + D - V₀ - C) / V₀ + (C × n ÷ 12)

Question 9

Why is MWR not a good way to compare different portfolios?

Answer 9

It’s strongly influenced by timing of cashflows, which is up to the client, not the manager

Question 10

What is the equation for time weighted return?

Answer 10

(1 + r₁) x (1 + r₂) … -1

Question 11

What is the equation for annual time weighted return?

Answer 11

(1 + TWR)¹/ⁿ -1

Question 12

What are two ways risk can be measured?

Answer 12

1. Volatility, measured by standard deviation
2. Systematic/market risk, beta (ß)

Question 13

What are three ways to measure risk-adjusted returns?

Answer 13

1. Sharpe ratio
2. Alpha (α)
3. Information ratio

Question 14

What is the formula for the Sharpe ratio?

Answer 14

(R - Rf) / standard deviation of R

Question 15

What is Jensen’s alpha (α)?

Answer 15

The difference between expected return, according to beta, and actual return

Question 16

What does Jensen’s alpha (α) measure?

Answer 16

The ‘value added’ by the fund manager

Question 17

What is the formula for Jensen’s alpha (α)?

Answer 17

α = R - [Rf + ßi (Rm – Rf)]

Question 18

What is the formula for the information ratio?

Answer 18

(Rp - Rb) / tracking error

Question 19

What is the tracking error?

Answer 19

The difference between the index return and a tracker fund’s return

Question 20

How do you calculate the contribution of an asset class to a portfolio’s overall performance?

Answer 20

Multiply the asset allocation % by the class’s performance %

Question 21

What does the Sharpe ratio measure?

Answer 21

The excess return for every unit of risk taken

Question 22

What is the Sharpe ratio used for?

Answer 22

Comparing investments to see which offers the most return for a given amount of risk

Question 23

A high Sharpe ratio means…

Answer 23

Better risk-adjusted performance

Question 24

What does a positive α mean?

Answer 24

The manager has outperformed the market, adjusting for ß

Question 25

What can sometimes cause negative alpha?

Answer 25

Management fees present in the fund’s return figures but not in the benchmark

Question 26

What does the information ratio measure?

Answer 26

The consistency with which a manager beats the benchmark

Question 27

What does a positive information ratio mean?

Answer 27

The manager has added value

Question 28

What does a negative information ratio mean?

Answer 28

The investor could probably have achieved a better return with a tracker fund