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CFA Book 5 Flashcards

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1
Q
A
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2
Q

trading | market mircostructure

A

structure and process of a market that affects securities’ pricing in relation to intrinsic value and the ability of managers to execute trades

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3
Q

trading | market order

A

executed at best price
• time certain (immediate), price uncertain

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4
Q

trading | limit order

A

set price
• price is certain (equal to or better), time (execution) is uncertain

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5
Q

trading | bid-ask spread

A
  • ask - bid
  • aka inside bid-ask spread or market bid-ask spread (ie the best bid and best ask)
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6
Q

trading | inside and market bid and ask

A

inside and market both mean the ‘best’ as in best bid or best ask or best bid-ask spread

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7
Q

trading | midquote

A
  • the avg of the ask and bid
  • the mid-point between the bid and ask
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8
Q

trading | effective spread given a transaction

A
  • for buy: 2 * (execution (buy) price - midquote)
  • for sell: 2 * (execution (sell) price - midquote)
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9
Q

trading | price improvement and price impact

A
  • price improvement: trade was executed within the bid-ask
  • price impact: trade was executed outside of the bid-ask
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10
Q

trading | avg of bid-ask and effective spread

A
  • bid-ask is unweighted
  • effective can be weighted or unweighted
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11
Q

trading | what do dealers do

A

they make the bid-ask with limit orders (in a limit order book)
• dealers = market makers

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12
Q

trading | securities markets offer 3 things

A
  1. liquidity
  2. transparency
  3. assurity of completion
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13
Q

trading | 3 type of securities markets

A
  1. quote-driven (aka dealer markets): investors and dealers
  2. order-driven: investors trade with investors
  3. brokered markets: investors use brokers to find counter-parties
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14
Q

trading | quote-driven market

A

• aka dealer market
• dealers make bid-ask spreads
• dealers needed in:
◎ low liquidity markets
◎ negotiated terms (eg. swaps)
• closed-book market: only brokers can see the order book

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15
Q

trading | order-drive market

A
  • more competition >> better customer prices
  • no intermediary dealers
  • no guaranteed liquidity
  • 4 types: electronic crossing network, auction, automated auction, hybrid
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16
Q

trading | ECN

A

electronic communications network
• automated auction market
• exp: NYSE/ARCA, Paris Bourse

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17
Q

trading | 3 types of order-driven

A
  1. electronic crossing network
    ◎ no price discovery
    ◎ periodic trading (crosses) of batch orders
  2. auction
    ◎ yes price discovery
    ◎ continuous and/or batch (eg. open/close)
  3. automated auction
    ◎ price discovery
    ◎ ECN
    ◎ continuous
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18
Q

trading | hybrid market

A

combination of parts of other 3 market types
• exp: NYSE

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19
Q

trading | dealer vs broker

A
  • dealer is a trader that takes the other side (and risk) of a trader
  • broker is a go-between representing the customer
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20
Q

trading | broker traits

A
  1. represent the order
  2. find counter-parties
  3. provide secrecy
  4. other services (eg. record keeping)
  5. support the market
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21
Q

trading | market: liquidity, trasparency, assurity

A
  • liquidity traits: narrow bid-ask, depth, resilience
  • liquidity inputs: many buyers/sellers, diverse opinions, convenient access, integrity
  • transparency: accessible quotes and order confirmations
  • assurance: clearing bodies and brokers guarantee both sides
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22
Q

trading | explicit costs

A
  1. commissions
  2. taxes
  3. stamp duties
  4. fees
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23
Q

trading | implicit costs

A
  1. bid-ask spread
  2. market, price impact
  3. opportunity costs
  4. delay costs (slippage)
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24
Q

trading | VWAP

A
  • metric to measure trading costs
  • volume weighted avg price
  • based on trade prices and volumes during the period (usually a day)
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25
Q

trading | measuring trading costs

A

can use VWAP or Implementation shortfall

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26
Q

trading | implementation shortfall

A

• metric to measure trading costs
• = (paper gain - actual gain) / paper investment
• actual trading vs paper trading
• actual trade price vs decision trade price (aka arrival price, strike price)
◎ decision price has no costs
• 4 categories
◎ explicit costs
◎ realized p/l
◎ delay, slippage cost
◎ missed trade opportunity
• can be share weighted
• can be dollar or % of decision price

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27
Q

trading | implementation shortfall: cost breakdown

A
  • commission
  • realized p/l = (actual - latest possible) / decision * % of order
  • delay p/l = (latest possible - decision) / decision * % of order
  • missed opportunity = (ending - decision) / decision * % of order
  • ALL THESE COSTS ARE DIV BY ORIGINAL SHARE * ORIGINAL DECISION PRICE!!!
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28
Q

trading | measuring costs with implement shortfall: market adjustment

A
  1. Calc Ri = alpha + beta * Rm; assume alpha = 0
  2. subtract Ri from prev calced % cost to find ‘market adjusted implementation shortfall’
    • negative cost is good
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29
Q

trading | cost measure: VWAP pros/cons

A

• pros:
◎ easy to understand
◎ easy to calc
◎ quickly applied to trading decisions
◎ good for small trades, non-trending mkt
• cons:
◎ bad for large volume trades
◎ possible to game
◎ not include delayed/unfilled order
◎ no include mkt movement/trade volume

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30
Q

trading | cost measure: implementation shortfall pros/cons

A

• pros:
◎ see cost of implementation
◎ see time vs price trade off
◎ decompose costs
◎ can be used in optimizer
◎ no gaming
• cons:
◎ novel to traders
◎ much data and analysis

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31
Q

trading | costs non-linearly corr with

A
  • liquidy: volume, mkt cap, spread, price
  • size of trade vs liquidity
  • trading style: more aggressive >> higher costs
  • momentum (buying stocks costs more when mkt going up)
  • risk
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32
Q

trading | cost forecasting: econometric model

A
  • can use econometric model regression to forecast cost and adjust size (ex ante)
  • can use to evaluate trades (ex post)
  • inputs: security liquidity, trade size, trade style, momentum, risk
  • based on microstructure
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33
Q

trading | trader types (as opposed to tactics)

A
  1. information-motivated: time sensitve >> mkt order
  2. value-motivated: price sensitive >> limit order
  3. liquidity-motivated: time sensitive >> mkt order
  4. passive: price sensitive >> limit order
  5. dealer/MM
  6. day trader
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34
Q

trading | trade tactics

A
  1. liquidity at any cost: information
  2. costs-not-important: information, liqudity
  3. need-trustworthy-agent: not information
  4. advertise-to-draw-liquidity: not information
  5. low-cost-whatever-the-liquidity: passive and value
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35
Q

trading | algorithmic

A

• automated trading using algorithms
• 1/4 of all trades
• 3 types:
◎ logical participation strat: simple, implemenation shortfall
◎ opportunistic strat: increases when liquidity increases
◎ specialized strat: various

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36
Q

trading | algorithmic: simple logical participation

A

• goal: minimize trading impact by breaking trade up into smaller parts
• 3 types:
◎ VWAP: trade volume weighted
◎ TWAP: done evenly over time
◎ % of volume: trades % of total volume until trade is finished

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37
Q

trading | algorithmic: implementation shortfall strategy

A
  • goal: minimize opportunity costs thru trading early >> trading early in day to avoid not executing
  • aka arrival price strategy
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38
Q

trading | best execution

A

• security acquisition/liquidation the best way
• similar to prudence (security selection)
• 4 traits:
◎ cannot be judged independently
◎ not known ex ante
◎ only know ex post over time and over multiple trades
◎ relationships and practices are important as is diligence

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39
Q

trading | CFAI Trade Management Guidelines

A

• 3 Parts:
◎ processes
◎ disclosures
◎ record keeping
• maximize portfolio value using best execution
• procedures and policies >> measure and manage
• provide clients: info and conflicts
• record keeping: policies/compliance and disclosures

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40
Q

trading | adverse selection risk

A
  • faced by dealers/mm
  • those most willing/anxious to trade against the dealers bid or ask may be the most well-informed (ie information traders)
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41
Q

rebalance portfolio | causes

A
  1. investor situation/goals
  2. capital markets changes (eg. business cycle)
  3. portfolio asset values
    • riskier assets will become larger % over time
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42
Q

rebalance portfolio | calendar rebalancing

A

rebalancing at pre-determined, regular intervals
• pros: disciplin
• cons: portfolio can become too unbalanced between rebalancing

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43
Q

rebalance portfolio | percentage-of-portfolio rebalancing

A

• aka PPR, percent range rebalancing, interval rebalancing
• tolerance bands, corridors = T +/- (T * P)
◎ T = asset allocation %
◎ P = max % chg
• P is specific to each asset class

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44
Q

rebalance portfolio | PPR: corridors

A

• 5 factors
1. high trans costs >> higher corridor
2. higher risk tolerance >> higher
3. higher corr with other assets >> higher
4. higher asset vol >> lower
5. higher other portfolio assets vol >> lower
• overall: sell winners, buy losers
• concave returns

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45
Q

rebalance portfolio | rebalance all the way?

A

depends on mkt trends and vol

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46
Q

rebalance portfolio | 3 strategies

A
  1. buy-and-hold: no rebalance; linear returns
  2. constant mix: calendar and PPR; sell winners, buy losers; concave returns
  3. constant proportion portfolio insurance (CPPI): buy winners, sell losers; convex returns
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47
Q

rebalance portfolio | constant prorportion portfolio insurance

A

• aka CPPI
• target weight equities investment = M * (portfolio value - floor value) = M * cushion
◎ M = constant proportion > 1 and does not change
• if M = 1 >> buy-and-hold
• if M < 1 >> CM
• overall: buy winners, sell losers
• convex returns

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48
Q

rebalance portfolio | 3 strategies vs mkt movements

A
  • mkt trends in one direction: best(CPPI, buy/hold, CM)worst
  • mkt mean reverts: best(CM, b/h, CPPI)worst
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49
Q

rebalance portfolio | NOTE: when assessing 3 strats, think of portfolio of risk-free asset (cash) and risky asset (equities) and what happens as the mkt moves

A
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50
Q

rebalance portfolio | 3 strategies vs risk tolerance

A
  • CPPI: absolute and relative risk tolerance pos corr with wealth (larger corr than others); dynamic cash floor that increases wth mkt decline
  • B/H: absolute and relative risk tolerance pos corr with wealth; static cash floor
  • CM: absolute risk corr w/ wealth, relative risk tolerance proportional to wealth (relative risk aversion); decreasing cash floor (constant %)
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51
Q

rebalance portfolio | causes: investor changes

A
  1. wealth
  2. time horizon (time passing, events)
  3. liquidity
  4. taxes
  5. legal and regulatory (for institutional)
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52
Q

evaluating performance | fund sponsor

A

institutions: pension fund, endowment, foundation that has multiple managers beneath it managing investments

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53
Q

evaluating performance | evaluation purpose from fund sponsor perspective

A

• feedback and control

  1. evaluates policy performance
  2. directs managers to most added and lost value
  3. quantifies active management and policy decision performance
  4. provides other strats that may be successful
  5. feedback on IPS implementation
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54
Q

evaluating performance | evaluation purpose from manager perspective

A

• provides details of performance and allows comparison to benchmarks

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55
Q

evaluating performance | evaluation components

A
  1. performance measurement: rates of returns
  2. performance attribution: sources of performance
  3. performance appraisal: causes of those sources (investment decisions, overall mkt , chance, etc)
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56
Q

evaluating performance | external cash flows into/out of the fund

A

these must be taken into account when calculating return

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57
Q

evaluating performance | time-weighted rate of return

A
  • geometric mean
  • compound rate of growth over multiple subperiods (delineated by external cash flows)
  • does not take into account timing of external CF or funds invested during each period >> evals manager decision, not investors external CF timing
  • used for GIPS and manager eval
  • harder to calc than MWRR
  • aka TWRR
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58
Q

evaluating performance | money-weighted rate of return

A
  • IRR
  • PV of CFs
  • takes timing into account of external CF and funds invested during each period >> groups together manager performance and investor external CF timing
  • not good manager eval unless they control external CF timing
  • easier to calc than TWRR
  • aka MWRR
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59
Q

evaluating performance | TWRR vs MWRR

A
  • if external CFs are large and returns are volatile, TWRR and MWRR can be very different
  • TWRR to measure manager’s performance because it excludes effects of investors external CF decisions (unless manager controls those decsions)
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60
Q

evaluating performance | matrix pricing

A

creating a mark for a security when none is directly available and looking at dealer quotes on a similar security

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61
Q

evaluating performance | 3 components of return (performance) attribution

A
  1. market
  2. management style
  3. active management
    • P = M + S + A
    ◎ P = manager’s portfolio return
    ◎ M = market return (not benchmark)
    ◎ S = B - M; B = benchmark (proxy for style)
    ◎ A = P - B
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62
Q

evaluating performance | 7 benchmark properties

A
  1. Specified in advance
  2. Appropriate
  3. Measurable
  4. Unambiguous
  5. Reflective of managments current investment opinions
  6. Accountable
  7. Investable
    • SAMURAI
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63
Q

evaluating performance | 7 types of benchmarks

A
  1. absolute
  2. manager universes
  3. broad market indices
  4. style indices
  5. factor-model-based
  6. returns-based
  7. custom security-based
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64
Q

evaluating performance | benchmark types: absolute

A
  • absolute return
  • pro: simple
  • con: not investable
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65
Q

evaluating performance | benchmark types: manager universes

A
  • median manager performance from broad unverise of funds
  • pros: measurable
  • cons: no advance ID, ambiguous, uninvestable, appropriateness unverifiable, fund sponsors have to rely on 3rd party compiler, survivor bias (upwards)
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66
Q

evaluating performance | benchmark types: broad market indices

A
  • broad mkt like S&P, etc
  • pros: understandable, unambiguous, investable, measurable, in advance
  • cons: often used when manager’s style is not the same (eg. small cap style)
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67
Q

evaluating performance | benchmark types: style indices

A
  • specific portion of asset category (eg. large cap equities)
  • pros: understandable, usually investable
  • cons: some indices are not smart investment strats, mis-classifying style
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68
Q

evaluating performance | benchmark types: factor-model-based

A
  • based on a factor model
  • pros: insight into manager’s style by defining factors
  • cons: unintuitive, difficult to calc, abiguous due to getting model correct
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69
Q

evaluating performance | benchmark types: returns-based

A
  • regressing time series of manager returns against various style indices to determine composite style benchmark
  • intuitive, meets benchmark criteria, use when only have acct returns
  • cons: style indices may not reflect manager’s style, enought data, not work if manager chgs style
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70
Q

evaluating performance | benchmark types: custom security-based

A
  • composite of manager’s allocations and investment process • meets benchmark criteria, continual monitoring, clear definition of allocation exposure (for sponsor allocation ease)
  • cons: expensive, impossible if lack of manager transparency (hedge funds)
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71
Q

evaluating performance | benchmark types: constructing custom security-based

A
  1. ID important elements of manager’s process
  2. select securites based on the process
  3. weight the securities based on the process
  4. review and adjust
  5. rebalance on predetermined schedule
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72
Q

evaluating performance | test of benchmark quality

A
  1. systemic bias
  2. tracking error
  3. risk characteristics
  4. coverage
  5. turnover
  6. positive active positions
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73
Q

evaluating performance | benchmark test quality: systematic bias

A

• if corr of portfolio to benchmark are not close (ie beta ~ 1), then portfolio may have different factors than benchmark
• where A = P - B, S = B - M, P = portfolio, B = benchmark, M = market
◎ active return (A) should not be corr with style return (S)
◎ S should be corr with P-M

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74
Q

evaluating performance | benchmarket test quality: tracking error

A

std dev of P-B < std dev of B-M
P = portfolio
B = benchmark
M = market

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75
Q

evaluating performance | benchmarket test quality: risk characteristics

A

systemic risk exposure should over time be the same for portfolio and benchmark

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76
Q

evaluating performance | benchmarket test quality: coverage

A

mkt val of securities in both portfolio and benchmark / mkt val of securities in portfolio

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77
Q

evaluating performance | benchmarket test quality: turnover

A

% of benchmark’s total mkt val that is bot/sold during rebalancing

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78
Q

evaluating performance | benchmarket test quality: positive active position

A
  • active position = portfolio weight of the security - benchmark weight of the security
  • absence of security in portfolio >> neg active position
  • large number of neg active positions is bad
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79
Q

evaluating performance | benchmarks for hedge funds

A

• difficult
◎ lack of transparency
◎ absolute return
◎ no definable style
◎ skewed returns (problem with sharpe)
• 3 possibilities:
◎ value-added return: benchmark weights sum to zero
◎ separate long/short benchmarks that are then combined
◎ Sharpe ratio

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80
Q

evaluating performance | performance attribution: 2 types

A

• macro:
◎ fund sponsor level
◎ % or dollars
◎ measure decisions of sponsor
• micro:
◎ portfolio manager level =measures value added by manager
• CFA test focuses on macro

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81
Q

evaluating performance | macro performance attribution: inputs

A
  1. policy allocations
  2. benmarket returns
  3. portfolio returns, valuations, external cash flows
    • when using %, returns are calced at individual manager level
    • when measuring in dollars, portfolio valuation and external CF are required to eval sponsor’s policies
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82
Q

evaluating performance | macro attribution analysis: 6 layers (levels)

A
  1. net contributions
  2. risk-free asset
  3. asset categories
  4. benchmarks
  5. investment managers
  6. allocations effects (plug number)
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83
Q

evaluating performance | macro attribution analysis: 6 layers: risk-free asset

A
  • layer 2
  • calcs the risk-free portion of the return on the beginning balance
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84
Q

evaluating performance | macro attribution analysis: 6 layers: asset categories

A

• layer 3
• calcs the asset clase return - risk-free return
• R = sum(Wa * (Ra - Rf))
◎ a = asset class
◎ R = return
◎ W = weight

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85
Q

evaluating performance | macro attribution analysis: 6 layers: risk-free asset

A

• layer 4
• calcs benchmark return - asset class return
• sum(Wa * Wb * (Rb - Ra))
◎ a = asset class
◎ b = benchmark return for each manager
◎ W = weight
◎ R = return

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86
Q

evaluating performance | macro attribution analysis: 6 layers: active management

A

• layer 5
• calcs active return - benchmark return
• sum(Wa * Wm * (Rm - Rb))
◎ a = asset class
◎ m = each manager
◎ W = weight
◎ R = return

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87
Q

evaluating performance | macro attribution analysis: 6 layers: allocation effects

A
  • layer 6
  • plug number to make: begin value + layers 1-5 + allocation effects = end value
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88
Q

evaluating performance | micro performance attribution

A

• compares portfolios to their benchmarks
• 3 layers:
◎ pure sector allocation: diff from benchmark based on diff asset allocation
◎ within-sector selection: diff from benchmark due to stock picking
◎ allocation/select interaction: overlap of diff asset allocation + stock picking

89
Q

evaluating performance | micro performance attribution: pure sector allocation layer

A

R = sum[(Wm,i - Wb,i) * (Rb,i - Rb,total)]
◎ Wm,i = manager sector weight
◎ Wb,i = benchmark sector weight
◎ Rb,i = benchmark sector return
◎ Rb,total = benchmark overall return
• diff from benchmark based on diff asset allocation

90
Q

evaluating performance | micro performance attribution: within-sector selection

A

R = sum(Wb * (Rm - Rb))
◎ m = manager decision
◎ b = benchmark
◎ W = weight
◎ R = return
• diff from benchmark due to stock picking

91
Q

evaluating performance | micro performance attribution: allocation/select interaction

A

R = sum((Wm - Wb) * (Rm - Rb)]
◎ m = manager decision
◎ b = benchmark
◎ W = weight
◎ R = return
• overlap of diff asset allocation + stock picking

92
Q

evaluating performance | fundamental factor model micro attribution

A

• use multifactor model to discover source of portfolio returns; coefficients for the factors indicate importance
• 4 components:
◎ ID fundamental factors for systematic returns
◎ determine portfolio and benchmark exposure to factors at beginning of period
◎ determine manager’s active exposure (manager vs benchmark) to factors
◎ measure active impact
• similar to returns-based style analysis

93
Q

evaluating performance | micro performance attribution vs fundamental factor model micro attribution

A

mico performance
◎ pros: disects manager’s performance between sectors and securities, easy
◎ cons: difficulty of defining appropriate benchmark
fundamental factor model
◎ identifies factors beyond secors and securities
◎ cons: exposure to factors needs to be determined before starting, difficult

94
Q

evaluating performance | fixed income attribution analysis

A

• main factors: duration and interest rates (different from equities)
• simulations of expected external interest rate environment to measure manager’s contribution
• sum of two calcs:
◎ external interest rate environment
◎ manager’s contribution

95
Q

evaluating performance | fixed income attribution analysis: external interest rate effect

A

2 calcs:
◎ if rates follow along the rate curve (expected interest rate effect)
◎ benchmark return based on what actually happened (unexpected interest rate effect)
◎ sum of these two = external interest rate effect = what the portfolio could have passively earned with benchmark

96
Q

evaluating performance | fixed income attribution analysis: 4 layers of manager’s contribution

A
  1. interest rate management effect (ie risk-free layer): how well mng predicts interest rate changes
  2. sector/quality management effect (sectors diff from the risk free): sector picking
  3. security-selection effect (bond picking within the sector)
  4. trading effect (plug value)
97
Q

evaluationg performance | risk-adjusted performance measures

A
  1. alpha (aka Jensen’s ex alpha or ex post alpha)
  2. information ratio (IR)
  3. Treynor measure
  4. Sharpe ratio
  5. M^2 (Modigliani ^ 2)
98
Q

evaluationg performance | risk-adjusted performance measures: which are aligned with beta and which with std dev and what is the difference

A

beta: Jensen’s alpha and Treynor measure
std dev of portfolio returns: sharpe ration and M^2
• beta has to do with systemic risk and std dev captures all risk
• systemic risk is related to the SML and CAPM (return vs beta); total risk is related to CAL and CML (return vs std dev)

99
Q

evaluationg performance | risk-adjusted performance measures: how are the Sharpe ratio and IR similar

A

both are excess return over the std dev of that return

100
Q

evaluating performance | alpha

A
  • CAPM and SML predict portfolio (asset) return = Rp = Rf + B * (Rm - Rf)
  • alpha = actual return - Rp
101
Q

evaluating performance | Treynor measure

A 
Tp = (Rp - Rf) / Bp 
Bp = portfolio beta
102
Q

evaluating performance | Sharpe ratio

A

Sp = (Rp - Rf) / std dev of a

103
Q

evaluating performance | M^2 measure

A

M^2p = Rf + (Rp - Rf) / std dev of p * std dev of market
•

104
Q

evaluating performance | difference between Treynor and Sharpe

A

Treynor is divided by beta (systemic risk), Sharpe by std dev (all risk)
• provides portfolio return if it had the same risk as the market

105
Q

evaluating performance | information ratio

A

IRp = active return / active risk = (Rp - Rb) / std dev of (Rp - Rb)

106
Q

evaluating performance | issues with alpha and Treynor

A

both based on CAPM assumptions (systemic risk model)

107
Q

evaluating performance | most widely used risk-adjusted measures

A

alpha, Treynor, Sharpe

108
Q

evaluating performance | IR indirectly uses beta how?

A

by using a benchmark, which has a systemic risk factor as part of its composition

109
Q

evaluating performance | quality control charts

A
  • plot alpha vs time with significance (confidence interval) bands around 0
  • null hypothesis is alpha = 0
110
Q

evaluating peformance | manager continuation policy

A
  • aka MCP
  • continual manager monitoring
  • regular, periodic manager reviews (similar to initial interview)
  • assessment of costs of removing manager vs benefits (like NPV analysis)
111
Q

evaluating performance | quality control chart: type I and II errors

A
  • null hypothesis: manager adds no value
  • type 1: incorrectly reject null >> keep bad manager
  • type 2: fail to reject null hypothesis >> fire good manager
112
Q

evaluating performance | NOTE: a fund sponsor can allocate a % to an asset category, then split that allocation up between diff managers

A
113
Q

evaluating performance | fixed-income portfolio attribution

A

• 2 components
1. effect of external interest rate environment:
◎ return on risk-free benchmark assuming moving along the curve
◎ return due to actual changes in interest rates
2. contribution of manager:
◎ interest rate management
◎ sector management
◎ selection (bond picking)
◎ trading

114
Q

evaluating performance | linked internal rate of return

A
  • aka linked IRR
  • proxy for TWRR
  • calculate MWRR over frequent time periods and then chain-link the returns over the entire period
115
Q

global performance | foreign investment return

A

R = CG + CF + C
◎ R = domestic return
◎ CG = cap gains on asset
◎ CF = dividends on asset
◎ C = e * (1 + CG + CF); e = % chg in foreign currency value

116
Q

global performance | foreign investment decomposition

A

decompose into:
1. yield in foreign currency
2. capital gains in foreign currency
3. currency contribution
• R = sum(Wm * CGm) + sum(Wm * Im) + sum(Wm * Cm)
◎ W = portfolio weight in foreign market m
◎ CG = % cap gains
◎ I = % yld on mkt
◎ C = e * (1 + CG + I); e = % chg in foreign currency
• does not include security selection and benchmark

117
Q

global performance | local and base currency

A 
local = foreign currency 
base = domestic currency
118
Q

global performance | local market (benchmark) return

A

R = sum(Wm * Ri,loc)
◎ Ri,loc = local market return for foreign mkt m

119
Q

global performance | foreign return attributable to manager’s security selection

A

Rsecsel = sum(Wm * Rm,secsel)
◎ Rsecsel = foreign return attributable to mng
◎ Wm = portfolio weight of mkt m
◎ Rm,secsel = portfolio - benchmark return for market m (return attrib to mng)

120
Q

global performance | foreign return attribution with security selection effects

A

Rportfolio = sum(Wm * Rm) + sum(Wm * (Rm,portfolio - Rm,benchmark)) + sum(Wm * Im) + sum(Wm * Cm)
◎ W = portfolio weight in foreign mkt
◎ Im = yld of foreign mkt m
◎ C = currency effect of foreign mkt m
• includes security selection and benchmarks
• no comparison to global benchmark (no mkt allocation)

121
Q

global performance | allocation effects

A

effects from manager selecting which mkts to invest in (vs securities)

122
Q

global performance | benchmark domestic return

A
  • global benchmark index in domestic currency
  • Rgb = sum(Wm,gb * Rm,gb) where Wm,gb = weight in global benchmark and Rm,gb,dom = return of mkt m in domestic currency
  • gb weights and return
123
Q

global performance | market allocation contribution

A

sum((Wm,portfolio - Wm,gb) * Rm
◎ Rm = return on mkt m in foreign currency
◎ gb = global benchmark
• aka sector allocation contribution

124
Q

global performance | currency allocation contribution

A

sum(Wm,portfolio * Cm,portfolio - Wm,gb * Cm,gb)
◎ W = weight in foreign mkt
◎ C = currency effect = Rdomestic - Rforeign
◎ gb = global benchmark
• sum all weights for countries using same currency

125
Q

global performance | portfolio decomposition (including everything)

A 
Rportfolio = benchmark domestic return + mkt allocation contribution + currency allocation contribution + security selection contribution + yld component 
• = sum(Wm,gb \* Rm,gb,dom) + sum((Wm,port - Wm,gb) \* Rm,gb) + sum(Wm,port \* Cm,port - Wm,gb \* Cm,gb) + sum(Wm,port \* (Rm,port - Rm,gb) + sum(Wm,port \* Im)
126
Q

global performance | active and passive currency management

A

passive:
1. fully hedging OR
2. no opinion and investing without regard to currency exposure
• both these are wrong; true passive management would be matching the benchmark currency hedge

127
Q

global performance | performance attribution over two periods

A

• 2-period active return = period 1 active * (1 + period 2 benchmark) + period 2 active * (1 + period 1 portfolio)

128
Q

global performance | multi-attribute analysis: security selection effect

A

SSE = sum(Wp * (Rp - Rb))
◎ W = weight
◎ R = return
◎ p = portfolio
◎ b = benchmark

129
Q

global performance | multi-attribute analysis: market allocation effect

A

MAE = sum((Wp - Wb) * (Rb,sector - Rb,total)
◎ W = weight
◎ R = return
◎ p = portfolio
◎ b = benchmark

130
Q

global performance | performance attribution over two periods: general rule

A
  1. each attributes contribution in the first period must be compounded at the benchmark rate of return over the second period
  2. each attribute’s contribution in the second period must be compounded with the portfolio return from the first period
131
Q

global performance | performance MULTI-attribution over two periods

A

• For each attribution over two periods:
1. Ra,total = Ra1 * (1 + Rb2) + Ra2 * (1 + Rp1)
◎ a = attribute return
◎ b = benchmark
◎ p = portfolio
◎ numbers indicate period
2. Total 2 period return including all attributes = sum all the attribute returns, Ra,totals

132
Q

global performance | performance over multiple periods: total return

A

=portfolio and benchmark compounded returns

133
Q

global performance | performance over multiple periods: notes

A
  • multi-period attribute return cannot be found by summing or compounding the attibute’s individual period returns
  • the attribute’s proportion of active return can change from period to period
134
Q

global performance | two common risk meaures

A
  • std dev of portfolio returns
  • std dev of active returns (Rp - Rb)
135
Q

global performance | two common risk-adjusted performance measures

A
  • Sharpe ratio (Rp - Rf)/std dev of Rp
  • Information ratio (active return / activer return std dev)
136
Q

global peformance | risk budgeting

A

allocating risk by manager
• risk counterpart to performance attribution

137
Q

global performance | two main portfolio risks

A
  1. absolute risk allocation (sector risk): asset class allocation
  2. active risk allocation (selection risk): tracking error allocation
138
Q

global performance | issues with historic manager performance

A
  1. luck or skill?
  2. mark to mkt issues
  3. skewed returns (selling small puts)
  4. survivorship bias within a firm’s funds
139
Q

global performance | 3 types of global benchmarks

A
  1. by country (GDP, mkt cap)
  2. int’l industries
  3. style
140
Q

global performance | remember percents

A

for most of these global performance equations every number is a percent

141
Q

GIPS | definition

A

ethical and professional standards for the presentation of investment performance results
• minimum set of standards
• est. 1999
• latest update 2010

142
Q

GIPS | CFAI, AIMR, GIPS, IPC

A
  • AIMR became CFAI
  • GIPS committe became IPC
143
Q

GIPS | benefits

A

existing and potential clients to compare firm performance across different countries and established practices

144
Q

GIPS | objectives

A
  1. global, industry wide best practices for the calculation and presentation of investment performace >> comparability across diff countries and practices
  2. accurate and unabiguous presentation of investment performance
  3. comparable historical performace data
  4. full disclousre and fair global competition without barriers
  5. self-regulation
145
Q

GIPS | characteristics

A
  1. voluntary, minimum standards
  2. requirements and recommendations (requirements compliance must be firm-wide)
  3. only investment firms, not individuals, pension plans or consultants
  4. min standard when local regulations do not exist
  5. performance must include all 1)fee-paying 2) discretionary portfolios in composites grouped by strategy/objective
  6. GIPS compliant 5 yr min at start, adding until a min of 10 yr
  7. include non-GIPS data if before 2000
  8. calc, presentation and disclosure requirements
  9. accurate input data is critical
  10. full disclosure and representation >> more than min GIPS
  11. firms may need additional disclosure beyond GIPS
  12. In local vs GIPS dispute, follow local and disclose
  13. recommend process and controls to enforce GIPS
  14. document policies to ensure client ownership of assets
  15. 2011 jan 1, is start of updated 2010 GIPS
146
Q

GIPS | scope

A

any firm in any country
• GIPS data compliant with pre-2006 GIPS may still be used

147
Q

GIPS | assets that must be GIPS compliant

A

• all the firm’s assets:
◎ paying and non-paying
◎ discretionary and non-discretionary
◎ funds with sub-advisoris IF the firm controls their selection
• all fee-paying, discretionary funds must be in at least on composite

148
Q

GIPS | compliance: definition of firm

A

an investment firm, subsidiary, or division held out to existing and potential clients as a distinct business entity
• business entity: organizationally or functionally distinct from other units and retains discretion of assets managed

149
Q

GIPS | compliance: writtten documentation

A

documentation of policies/procedures is required

150
Q

GIPS | compliance statement

A

XXX claims compliance with the GIPS and has prepared and pesented this report in compliance with the GIPS standards. XXX has not bene independently verified.
• NO partial compliance

151
Q

GIPS | Input Data REQuirements (1.A.X)

A

1A1. all data must be stored (ability to recreate calcs)
1A2. 2011+, fair value only
1A3. 2001+, monthly valuations; 2010+, monthly and large external CFs
1A4. 2010+, end-of-month (cal or bus day) valuation
1A5. 2005+, trade-date accounting (not settlement)
1A6. accrual accounting for interest accruing assets
1A7. 2006+, begin and end calendar year valuations

152
Q

GIPS | Input Data RECommendations (1.B.X)

A

1B1.value at every external CF (not just large)
1B2. 3rd party valuations
1B3. accrue dividends as of ex-div (not payment)
1B4. accrual accounting for management fees

153
Q

GIPS | Calculation Methodology REQuirements (2.A.X)

A

2A1. use total returns (incl unrealized cap gains); ie holding period return
2A2. use time-weighted rate of return (TWRR)
2A3. cash must included in total return calcs
2A4. returns must include direct actual (not estimated) fees
2A5. if direct fees cannot be calced, the bundled fees or % of bundle that is direct fees (no estimates)
2A6. composite returns must be asset-weighted (composite = multiple portfolio): ie. larger portfolios have more weight
2A7. 2006+, asset weighted comp return at least qtyly; 2010+, at least monthly

154
Q

GIPS | Accounting for cash flows: Original Dietz

A
  • allowed until 2005
  • Rdietz = (end value - begin value - CF) / (begin value + .5 * CF)
  • assumes CF occurs midway throught the period
155
Q

GIPS | Accounting for cash flows: Modified Dietz

A

• allowed until 2010
• Rmdietz = (end value - begin value - CF) / (begin value + sum(Wi * CFi))
◎ Wi = (cal days in month - cal date of CF) / cal days in month

156
Q

GIPS | Accounting for cash flows: Modified Internal Rate of Return

A

• allowed until 2010
• aka MIRR, Modified Banker Administration Institute (BAI) Method
• solving for R from: end value = sum(CFi * (1 + R)^Wi + begin value * (1 + R)
◎ Wi = proportion of period CF was in (or out, if outflow and negative) from the portfolio

157
Q

GIPS | Accounting for cash flows: TWRR

A
  • required 2010+
  • effectively daily valuation (no estimates of CF impact):
  • daily returns: R = (end value - begin value)/ begin value
  • TWRR = geometric mean of daily value returns
158
Q

GIPS | composite return calculation: beginning value + cash flows

A
  • begin value + cash flow weighted return
  • R = sum((begin value i + sum(CFi * Wi)) * Ri) / sum(begin value i + sum(CFi * Wi))
  • i = portfolio i
159
Q

GIPS | composite return calculation: aggregate modified Dietz

A

R = (sum(end value i) - sum(begin value i) - sum(CFi)) / (sum(begin value i) + sum(CFi * Wi))
• Wi = (CalDay - Di) / CalDay

160
Q

GIPS | Calculation Methodology RECommendations (2.B.X)

A

2B1. return calc net of non-claimable taxes; reclaimable taxes are accrued

161
Q

GIPS | Composite definition

A

aggregation of discretionary portfolios into a single group that have a common objective or strategy
• primary method for presenting performance to potential clients

162
Q

GIPS | composite return

A

asset weighted return of all the portfolios in the composite

163
Q

GIPS | Portfolios & Composites REQuirements (3.A.X)

A

3A1.
◎ all actual, fee-paying, discretionary portfolios must be in at least on composite (or many)
◎ non-paying, descretionary can be included
◎ non-discretionary cannot be included
◎ if portfolio goes discretionary >> non-discretionary, change is prospective
3A2. only include AUM with the firm
3A3. cannot combine simulated/model performance with actual performance
3A4. composites are defined by similar strategy or objective and include all portfolios that meet the specific composite definition
3A5. include new portfolios on a timely basis
3A6. terminated portfolios must be included upto last full period
3A7. cannot switch portfolios without documented IPS or composite definition change (always prospective)
38A. 2010+, carve-outs are not included in composite
3A9. if composite asset min exists, must be followed (all composite definition changes are prospective)
3A10. temporary removal or separate acct allowed for large CF inflows to avoid cash drag on composite

164
Q

GIPS | discretionary definition

A
  • ‘the ability of the firm to implement its intended strategy’
  • IPS restrictions do not automatically disqualify until they stop ability to implement
165
Q

GIPS | Portfolios & Composites RECommendations (3.B.X)

A

3B2. to avoid cash drag from large CF inflows, use temporary separate account for CF

166
Q

GIPS | carve-out

A

sub-set of portfolio’s assets for generating a track record of specific asset class

167
Q

GIPS | Disclosure REQuirements (4.A.X) and RECommendatiosn (4.B.X)

A

read the material

168
Q

GIPS | Presentation REQuirements: 5.A.1

A
  1. 5 yr min performance presentation at start, growing to 10yr (less is ok if too new)
  2. ID annual returns as gross/net of fees
  3. 2011+, new composites returns presented EOY even if partial
  4. 2011+, terminated composities returns to last day of existence
  5. annual benchmark returns per portfolio
  6. # of portfolios in composite EOY (unless
  7. assets in composite EOY
  8. total firm assets or total composite/total firm assets EOY
  9. dispersion of composite’s portfolios EOY eg. std dev (unless
169
Q

GIPS | Presentation REQuirements 5.A.2 - 5.A.7

A

5A2. 2011+, 3yr annualized ex-post std dev monthly returns for composite and benchmark (+ 3yr of a diff measure if firm doesn’t like std dev)
5A3. include non-GIPS returns prior to 2000
5A4. comps and ports existing
5A5. 2006-2011, %comp that was carved out on annual basis
5A6. % of comp that is non-fee-paying
5A7. % of comps that are bundled fee
5A8.

170
Q

GIPS | Presentation REQuirements 5.A.8

A

• generally, composite performance is not portable to other firms
• never to off-shoots or new firms (eg. manager starts his own firm)
• an acquirer must keep performance if:
◎ managers remain with the acquirer
◎ decision process remains the same
◎ acquirer has documentation of past performance
• acquirer has one year to bring acquired accts into line with GIPS

171
Q

GIPS | Presentation RECommendations (5.B.X)

A

5B1. present gross of fee returns
5B2. present:
◎ cumulative comp and bench returns across all periods
◎ equal-weighted mean and median returns per comp
◎ qtrly, monthly returns
◎ annualized comp and bench returns for periods >12 months
5B3. 2011+, 3yr annualized ex post std dev of monthly returns for every year for comp and bench
5B4. annual return for comp and bench
5B5. annualized std dev of monthly returns for comp and bench
5B6. additional ex post comp risk measures
5B7. >10yrs of performance
5B8. comply with GIPS for all past periods
5B9. update presentations qtrly

172
Q

GIPS | real estate that falls under ‘general’, not ‘real estate’ GIPS rules

A
  1. publically traded real estate securities (eg. REITs)
  2. CMBS
  3. private debt investments, including commercial and residential loans that only receive interest and do not share in real estate value changes
173
Q

GIPS | PE that falls under ‘general’, not ‘PE’ GIPS rules

A

open-ended and evergreen funds (no fixed capital levels or number of investors)

174
Q

GIPS | real estate REQuirements

A

6A1-3. upto 2008, market value every 12 months; 2008+, qtrly; 2010+, qrtly at end of qtr
6A4-5. upto 2012, external valuation every 3 yrs; 2012+ annually (if client states otherwise, every 3 yrs)
6A6-7. returns less transaction costs qtrly
6A8. 2011+, income and capital components calced separately using TWRR
6A9. asset-weighted composite and component returns every qtr using TWRR

175
Q

GIPS | real estate | capital employed (invested)

A

Ce = Co + sum(CFi * Wi)
◎ Wi proportion of period the CF was in (inflow) or missing (outflow)

176
Q

GIPS | real estate: capital return

A
  • % chg in property value after capital improvement and sales proceeds
  • Rc = (end value - begin value - CapX + sales) / capital employted
177
Q

GIPS | real estate: income return

A

Ri = (Ya - Er - Id - Tp) / Ce
◎ Ya = gross investment income
◎ Er = nonrecoverable exp (leasing, maintenance) not directly reimbursed by tenants
◎ Id = interest on debt
◎ Tp = property tax

178
Q

GIPS | total return

A

Rt = Rc + Ri

179
Q

GIPS | monthly vs annual returns

A
  • sub-period returns = income return + capital return
  • total period return = TWRR of monthly returns
180
Q

GIPS | PE REQuirement categories

A
  1. input data
  2. calculation methodology
  3. composite construction
  4. disclosures
  5. presentation and reporting
181
Q

GIPS | PE REQuirements: 7.A.21 - 22

A

7A21. present both net-of-fees and gross-of-fees annualized SI-IRR of the composite for each yr since inception
7A22. 2011+, present SI-IRR of investments in fund of funds grouped by vintage year; gross of fund of fund fees

182
Q

GIPS | PE: SI-IRR

A

since inception IRR

183
Q

GIPS | PE REQuirements: 7.A.23

A

report:
1. since inception paid-in capital
2. cumulatie committed capital
3. since inception distributions
4. total value to paid-in capital (investment multiple of TVPI)
5. cumulative distributions to paid-in capital (realization multiple or DPI)
6. Paid-in capital to committed capital (PIC multiple)
7. Residual value to paid-in capital (RVPI)

184
Q

GIPS | PE REQuirements 7.A.24

A
  • present cumulative annualized SI-IRR for the benchmark that reflects the same strat and vintage year as composite
  • if no benchmark presented, explain why
185
Q

GIPS | PE RECommendations (7.B.1-3)

A
  • qtrly valuations
  • pre 2011, SI-IRR calced using daily cash flows
186
Q

GIPS | Valuation principles

A
  • 2011+, fair value valuations including accrued income
  • follow local laws and disclose any conflict
  • disclose portfolio valuation policies
  • 2011+, disclose subjective valuation
  • disclose if valuation hierarchy is different from GIPS
187
Q

GIPS | valuation hierarchy

A

• recommended
• source ranking for valuations
1. objective, unadjusted mkt prices
2. quotes prices
3. mkt-based inputs other than quoted prices
4. subjective

188
Q

GIPS | SMA REQuirements

A
  1. ID periods in composite prior to SMA inclusion
  2. disclose non-compliant performance pre-2006
  3. provide potential SMA clients with all similar SMA performance
  4. deduct bundled fees from returns
  5. for presenting sponsor-specific comps, must disclose sponsor
  6. may link non-compliant pre-2006 performance to compliant 2006+
189
Q

GIPS | real estate valuation principles

A
  1. external valuation
  2. valuator’s fee not based on valuation
  3. single value - not range
  4. rotate valuators 3-5 yrs
190
Q

GIPS | PE valuation principles

A
  1. most appropriate valuation method
  2. must account for: reliable data, comparables, stage of deveopment, unique characteristics
191
Q

GIPS | Advertising Guidelines

A

read the material

192
Q

GIPS | general points about presentation

A
  • don’t annualize when performance < 1yr
  • calc return upto current data (don’t leave out most recent)
  • disclose significant leverage/derivatives
  • can include but must disclose non-compliant performance pre-2001
  • may include date compliant with old GIPS versions pre-2006
  • benchmark stats that mirror composite (and if no benchmark, explain)
  • list and description of all composities is available upon request
193
Q

GIPS | verification by 3rd party definition

A

review of an investment management firm’s performance-measurement processes and procedures by an independent 3rd party verifier
• verification is recommended but voluntary

194
Q

GIPS | verification standards

A
  1. firm has complied with all composite construction reqs on a firm-wide basis
  2. firm’s processes/procedures are designed to calc and present performance compliant to GIPS
195
Q

GIPS | verification notes

A
  1. must be firm-wide (not partial)
  2. minimum compliant history is 1 yr
196
Q

GIPS | country sponsors

A

an agent of the main GIPS executive council to implement GIPS in individual countries

197
Q

GIPS | after-tax return methods

A
  1. pre-liquidation: only looks realized p/l to calc taxes
  2. mark-to-liquidation: look at all cap gains, realized or unrealized; ignores benefits of postponing cap gains taxes
    • 2011+, after-tax info must presented as supplemental
198
Q

GIPS | after-tax benchmark return

A

if portfolio/composite after-tax returns are presented, so should after-tax benchmark returns
• must reflect client’s tax status (in addition to 7 other reqs)

199
Q

GIPS | benchmark reqs including after-tax

A
  1. advance specification
  2. appropriate
  3. measurable
  4. unambiguous
  5. similar to mng’s investment opinion
  6. accountable
  7. investable
  8. reflective of client’s tax status
200
Q

GIPS | which benchmark to use for after-tax

A

helpful to use: ETFs, custom security benchmarks, shadow portfolios

201
Q

GIPS | after-tax returns: client directed trades and resulting tax effects

A

these are not discretionary and should be addressed

202
Q

GIPS | performance table REQuirements

A
  1. year
  2. total return
  3. benchmark return
  4. # of portfolios
  5. composite dispersion
  6. total assets at end of period
    either:
    ◎ % of firm assets OR
    ◎ total firm assets
203
Q

GIPS | real estate & PE: portion of portfolio is direct real estate/PE investments

A

special provisions only apply to that portion of the portfolio that are directly invested in real estate/PE, no more, no less

204
Q

GIPS | real estate: REQuired disclosures

A
  1. methodology used to calc returns (chain-linked, TWRR)
  2. discretionary definition
  3. internal valuation methods
  4. freq of outside evaluator
  5. 2011+, material valuation policy changes
  6. 2011+, diff between external and reported valuations expanation
  7. pre-2011, if component returns adjusted to have tota returns
  8. pre 2006 non-compliance
  9. deducted fees other than trans fee in gross-of-fee returns
  10. deducted fees other than mng and trans fees in net-of-fee returns
205
Q

NOTE: MUST REREAD GIPS SECTIONS!!!

A
206
Q

GIPS | real estate closed-end: returns reqs

A

SI-IRR since inception using qrtly CF

207
Q

GIPS | real estate closed-end: composite construction reqs

A
  • vintage year
  • similar strategy
208
Q

GIPS | real estate closed-end: disclosures reqs

A
  1. final liquidation date (if liqed)
  2. freq of CF used in SI-IRR
  3. vintage year of composite
209
Q

GIPS | real estate closed-end: presentation reqs

A

read the material

210
Q

GIPS | PE: input data reqs

A
  1. assets valued annually
  2. 2011+, valued at fair value
211
Q

GIPS | PE: calculation methodology reqs

A
  1. annualized SI-IRR
  2. pre-2011, daily or monthly CF to calc SI-IRR; 2011+ daily CF (stock distributions included as CF)
  3. net-of-fees include mng fees and carried interest
  4. trans expenses deducted prior to return calc
  5. fund of fund returns calced after deducting partnership fees, fund fees, expenses and carried interest
212
Q

GIPS | PE: composite construction reqs

A
  1. composite definitions must not change
  2. primary funds and fund of funds must be included in at least one composite based on vintage year and start
213
Q

GIPS | PE: disclosure reqs

A
  1. vintage year and vintage year definition per composite
  2. liquidation data if applicabe
  3. valuation methodology; 2011+, materia chgs in methodology
  4. industry guidelines followed (in addition to GIPS)
  5. benchmark and return calc methodology
  6. fees other than trans deducted prior to gross-of-fees calc
  7. fees other than mng and trans fees deducted prior to net-of-fee calc
  8. non-compliance pre-2006
214
Q

GIPS | gross vs net return

A

In general, gross-of-fee returns has transaction fee deducted and net-of-fees has managment and transaction fees deducted

215
Q

GIPS | PE: presentation and reporting

A

read the material

216
Q

GIPS | distinct business entity definition

A

unit, division, dept, office that is organizationally or functionally different separated from others and retains discretion over assets it manages and autonomy over investment decision making process

217
Q

GIPS | 3 forms of GIPS certification

A
  1. firm compliance with GIPS without validation
  2. firm compliance with GIPS with validation
  3. composite compliance with GIPS with validation IF firm is already compliant
218
Q

GIPS | PE: valuation method rankings

A
  1. market transactions
  2. market-based multiples
  3. discounted CF

CFA (11 decks)

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