Chapter 15: Performance measurement (1)

Question 1

When calculating rates of return, take extra care with:

Answer 1

1. the timing and size of all cashflows
2. differentiating between investment income and new money
3. tax and expenses

Question 2

Money-weighted rate of return (MWRR): (2)

Answer 2

1. The money-weighted rate of return is found by equating the present value of money in with the present value of money out.
2. It is affected the timing and size of cashflows

Question 3

Time-weighted rate of return (TWRR): (2)

Answer 3

1. The time-weighted rate of return is found by linking the rates of return for each inter-cashflow period.
2. This is not affected by the size or timing of cashflows.

Question 4

Linked internal rate of return: (2)

Answer 4

1. The linked internal rate of return is a practical approximation for the time-weighted rate of return.
2. It is found by linking the internal rate of return calculated over short periods.

Question 5

Sector selection profit

Answer 5

Sector selection profit arises from the differences between the fund’s choice of proportions in the various sectors and the proportion in the benchmark portfolio

Question 6

Stock selection profit

Answer 6

Stock selection profit arises when the selected stocks within a particular sector perform better or worse than the sector as a whole.

Question 7

Risk adjusted performance measures (4)

Answer 7

1. Treynor measure
2. Sharpe measure
3. Jensen measure
4. pre-specified standard deviation

Question 8

The main uses of performance measurement are to: (4)

Answer 8

1. help improve performance
2. compare actual performance against target rates
3. compare actual performance against benchmark or other portfolios
4. appraise and remunerate investment managers

Question 9

Limitation of performance measurement (6)

Answer 9

1. the past may be a poor guide to the future
2. the difficulty of allowing for risk
3. the possibility of spurious and/or misleading results if invalid comparisons are made or time periods that are too short are considered
4. different funds may have differing objectives
5. measurement may influence the actions of fund managers in ways that are inconsistent with the fund’s long-term objectives
6. it adds to the cost of investment.

Question 10

Relative merits of performance relative to published indices: (4)

Answer 10

Advantages:
1. Relatively easy to do

2. Data is readily available and reliably accurate

Disadvantages:
3. Index might not be appropriate

4. There may be no single index which is consistent with the objectives of the investor.

Question 11

Limitations of the Treynor measure: (4)

Answer 11

1. The Treynor measure assumes that the CAPM holds, i.e. that beta is a sufficient and appropriate measure of systematic risk.
2. Assumptions underlying the CAPM include that either investors have quadratic utility functions or that investment returns are distributed elliptically symmetrically (i.e. normally)
3. Returns of real asset classes tend to be non-normal, exhibiting skewness and leptokurtosis.
4. The Treynor measure further makes no allowance of actuarial risk or downside risk.