Chapter 10 Flashcards
The statistics used to measure performance must meet which requirements? (5)
- Unambiguous
- Investable
- Measurable
- Appropriate
- Specified in advance
For performance evaluation, what does unambiguously mean?
weights of securities and factor exposures of benchmarks are clearly defined
For performance evaluation, what does an investable benchmark mean?
can stop active management and just buy the benchmark as a passive portfolio
For performance evaluation, what does measurable mean?
returns and risk of portfolio can be calculated quickly and frequently
For performance evaluation, what does an appropriate benchmark mean?
the benchmark is consistent with the manager’s investment style or area of expertise
For performance evaluation, what does specified in advance mean?
stated on the IPS and is known to all parties
What is peer group benchmarking?
has the manager outperformed peer group’s median performance?
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
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
What happens when limits set on customised benchmarking are set tight?
might make the portfolio a pseudo tracker
For performance evaluation, what is objectivity?
historic performance is analysed against some baseline
not open to dispute
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
Why is performance evaluation required?
compares managers’ performance
show if portfolio meets requirements
What is absolute performance?
an absolute return can simply be a return objective, without reference to any another benchmark or similar comparator
What does absolute performance aim to show?
whether total return is commensurate with total risk experience
What should a suitable performance measure include?
return target and risk target
How does an absolute performance measure help an investor?
helps understand whether return offered is appropriate to level of risk taken
What is relative performance?
return compared to benchmark or peers
What are the three standard risk-adjusted measures?
jensens
sharpe
treynor
What is jensens measure?
post alpha return
uses beta
What is sharpe ratio?
return of portfolio measured in standard deviation terms
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
