Chapter 10 Flashcards by Alkaid Arao

The statistics used to measure performance must meet which requirements? (5)

Unambiguous
Investable
Measurable
Appropriate
Specified in advance

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For performance evaluation, what does unambiguously mean?

weights of securities and factor exposures of benchmarks are clearly defined

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For performance evaluation, what does an investable benchmark mean?

can stop active management and just buy the benchmark as a passive portfolio

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For performance evaluation, what does measurable mean?

returns and risk of portfolio can be calculated quickly and frequently

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For performance evaluation, what does an appropriate benchmark mean?

the benchmark is consistent with the manager’s investment style or area of expertise

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For performance evaluation, what does specified in advance mean?

stated on the IPS and is known to all parties

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What is peer group benchmarking?

has the manager outperformed peer group’s median performance?

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What is a critique of peer group benchmarking? (3)

the investment decision will be based on what other fund managers are doing

creates herding mentality

everyone else could be bad but the least bad will be shown as the best - even though absolute performance is still poor

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When is customised benchmarking appropriate? (2)

asset allocation decision and stock selection decisions are separable

e.g. asset allocation decided by trustee, stock selection done by fund managers

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What happens when limits set on customised benchmarking are set tight?

might make the portfolio a pseudo tracker

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For performance evaluation, what is objectivity?

historic performance is analysed against some baseline

not open to dispute

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For performance evaluation, what is subjective? (3)

involves making predictions about the future

there is no way to perfectly model economic systems

use subjective views

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Why is performance evaluation required?

compares managers’ performance

show if portfolio meets requirements

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What is absolute performance?

an absolute return can simply be a return objective, without reference to any another benchmark or similar comparator

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What does absolute performance aim to show?

whether total return is commensurate with total risk experience

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What should a suitable performance measure include?

return target and risk target

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How does an absolute performance measure help an investor?

helps understand whether return offered is appropriate to level of risk taken

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What is relative performance?

return compared to benchmark or peers

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What are the three standard risk-adjusted measures?

jensens
sharpe
treynor

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What is jensens measure?

post alpha return

uses beta

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What is sharpe ratio?

return of portfolio measured in standard deviation terms

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What is the Treynor ratio?

scales returns in terms of beta

What is the appraisal ratio?

An appraisal ratio is a ratio used to measure the quality of a fund manager’s investment-picking ability. The ratio shows how many units of active return the manager is producing per unit of risk

What is the appraisal ratio useful for?

active management within a portfolio by reference to the performance of a passive tracker fund

How do you calculate the appraisal ratio?

Appraisal ratio = portfolio alpha / portfolio unsystematic risk

What does the appraisal ratio tell you?

if exceeds benchmark sharpe ratio, then active performance produced superior returns

What does the information ratio measure?

manager's skill

how to calculate information ration?

IR = excess return / excess standard deviation

How to calculate sharpe ratio?

Sharpe ratio = (Return of fund - risk free rate)/standard deviation of fund

How to calculate Treynor ratio?

Treynor ratio = (return of fund - risk free rate)/beta of fund

What does a higher IR mean? (2)

higher information ratio higher active return given the amount of risk taken

Difference between sharpe ratio and IR?

shapre ratio based on risk free rate IR based on benchmark performance

What does VaR tell?

the expected maximum loss over a given time at a specified confidence level

What does the CVaR tell?

the expected, probability-weighted average loss, that is conditional on the loss being equal to or greater than VaR

What is a disadvantage of VaR and CVaR?

they assume that return distributions are normal

How can VaR and CVaR be improved upon? (4)

- add asymmetry - skewness and kurtosis - requires monte-carlo simulations - too advanced numerical procedure

What is a criticism on volatility?

It makes no distinction between positive and negative returns and it assumes returns will be normally distributed

How does Parametric VaR help?

improves on volatility by only considering negative returns, but still assumes a normal distribution

What does drawdown show?

loss of value in currency terms relative to a high-water mark

By tracking the evolution of a drawdown index over a period of time, a portfolio/fund manager can determine what values? (3)

- worst drawdown - average drawdown - longest drawdown period to recovery

What is r-squared?

is a statistical value which is associated with the correlation coefficient and linear regression

What does a high r-squared show?

the greater the confidence we can have that there is a strong relationship between two variables

If the correlation coefficient is 0.9, what is r-squared?

0.81

What does a value of 0.81 for r-squared say?

81% of co-movement between the variables is explained by the linear equation the other 19% is not explained by the variables in the regression

What return do you use to deduct from the fund return when calculating the sortino ratio?

- returns less than the target requirement or reference rate

What is the risk used in the calculation of sortino ratio?

- standard deviation of returns below the target return or reference rate

What is the expense ratio?

a measure of the total cost of investing in a fund

what is included in the expense ratio? (3)

management operation administrative fees as a percentage of the total assets managed

How to calculate total expense ratio (TER)?

TER = operating expenses/average monetary value of AUM

How often is TER calculated?

The TER is calculated at least once a year on an ex-post basis and is provided in a fund’s annual reports.

How does ongoing charges figure (OCF) differ from the TER?

it does not include any performance fees which should be disclosed separately by the fund manager

What is OCF?

ongoing or recurring charges

What analysis might TER or OCF become less relevant? (2)

performance evaluation uses historical data performance analysis should have deducted fees and charges already

What does the FCA recommend regarding OCF?

be used consistently in all marketing material for UCITS