CFA Level III Reading 41 Flashcards
Demonstrate the importance of performance evaluation from the perspective of Fund Sponsors.
Performance evaluation improves the effectiveness of a fund’s investment policy by acting as a feedback and control mechanism. It:• Identifies effective & ineffective policies. • Identifies areas of underperformance. • Indicates the results of active management & other policy decisions. • Indicates need for additional policies/actions. • Determines whether IPS policies are being followed consistently.
Demonstrate the importance of performance evaluation from the perspective of Investment Managers.
Performance evaluation can serve as a feedback and control mechanism.• To measure the effectiveness of all aspects of the investment process
What part of the Investment Management Process does Performance Evaluation fall under?
performance evaluation is part of the feedback step of the investment management process
What are the 3 components of portfolio valuation?
- Performance Measurement2. Performance Attribution3. Performance Appraisal
Explain Performance Measurement
The return performance of the account over the period.It involves calculating rates of return based on changes in the account’s value over specified time periods.Compute the return - cash flows & impact to total return
Explain Performance Attribution
How the manager(s) attained the observed performance.This looks into the sources of the account’s performance (e.g., sector or security selection) and the importance of those sources. Determines the source of the return (macro or micro)
Explain Performance Appraisal
Whether the performance was due to investment decisions.The objective is to draw conclusions regarding whether the performance was affected primarily by investment decisions, by the overall market, or by chance.Asses whether the return is due to skill
What is the time-weighted rate of return (TWRR)?
TWRR the compounded rate of growth over a stated evaluation period of one unit of money initially invested in the account. It requires a set of subperiod returns to be calculated covering each period that has an external cash flow. The subperiod results are then compounded together.TWRR is a geometric average of individual sub-period returns.
What is the money-weighted rate of return (MWRR)?
MWRR is the internal rate of return (IRR) on all funds invested during the evaluation period, including the beginning value of the portfolio.MWRR is an equal, compounded return in each sub-period.
Advantages of TWRR
Unaffected by the timing of external cash flowsUsed when managers have little or no control over external cash flows
Advantages of MWRR
Only appropriate if the manager has control over external cash flows.Only requires account values at the start & end of the period.
Disadvantages of TWRR
Account valuations are required with every significant external cash flow.Prone to errors.More expensive.Not for use with illiquid assets.
Disadvantages of MWRR
Distorted by the size & timing of cash flows.Biased upward (downward) with large contribution just prior to up (down) move in the market.Not suitable if a manager has no control over external cash flows.
Identify and explain potential data quality issues as they relate to calculating rates of return.
The following are potential problems relating to data quality:When accounts contain illiquid (infrequently priced) assets, estimates or educated guesses must sometimes be used to calculate returns. For many thinly traded fixed-income securities, current market prices may not be available. Estimated prices may be derived from dealer quoted prices on securities with similar attributes. This is known as matrix pricing. Highly illiquid securities may be carried at cost or the price of the last trade, thus not reflecting the current price. Account valuations should include trade date accounting, including accrued interest and dividends.
