Chapter 16: Performance Measurement (1) Flashcards
State
- The standard formula for calculating the money weighted rate of return
- The main advantages and disadvantages of using it to assess the investment manager’s performance
V0(1+i)T+Σ(1+i)T - t = VT
- V0, VT are market values of fund at beginning and end of period
- Ct is net cashflow into fund (excluding investmetn proceeds) at time t i is money weighted rate of return
- i is money weighted rate of return
+ Represents actual rate of return earned by the fund and so can be compared with actuarial assumptions
- Depends on timing and amounts of net cashflows into funds. If these outside manager’s control, then unfair to compare performance based on MWRR against other managers
State a formula for the time weighted rate of return
State the main advantages and 2 disadvantages of TWRR
Explain how the linked internal rate of return (LIRR) is calculated
List the circumstances under which it will give a close approxiation to the TWRR
Calculated by
- Determining fund at various dates throughout year
- calculating internal rate of return for each intervaluation period
- linking inter - valuation rates of return to get linked internal rate of return
Get close approximatioin to TWRR if
- Short intervaluation periods are used or
- Valuations occur close to dates of casfhlows or
- Cashflows are sall relative to size of the fund or
- Rate of return is very stable over each intervaluation period
Give the two basic ways in which to compare the performance of a portfolio with an index
Outline how the performance of a portfolio can be compared against a notional fund
Two basic ways to compare performance of portfolio with index
- Compare actual value of portfolio at end of period with that would have achieved had inital value of portfolio and subsequent net new money been invested in same way as index
- Compare the time weighted return or (LIRR) from eah
High performance of portfolio can be compared against notional fund
- SImilar to assessing against a published index
- Difference is notional fund not based on particular market index, but definied in some other, predermined way
- need ot allow carefully for income, net new money, rebalancing, tax and expense
Explain how to split the overall outperformance of an investment fund into sector selection and stock selection components
Sector selection and stock selection components
- rAA = Return based on actual sectors and actual stocks
- rAN = return based on actual sectors and notional stocks
- rNN = return based on notional sectors and notional stocks
then
- stock selection component = rAA - rAN
- sector selection component = rAN - rNN
- Overall outperformance = (rAA -rAN) + (rAN - rNN) = rAA - rNN
State the formula used to estimate
- The stock selection component attributable to equities
- the sector selection comoponent attributable to equities
Stock selection omponent attributable to equities
WEA x (rEA - rEN)
Sector selection component attributable to equities
(WEA - WEN) x (rEN - rNN)
Where
- WEA & WEN are actual and notional equity weights
- rEA &rEN are actual and notional equit returns
- rNN is overall fund return based on notional stocks
State the formula for the four risk adjusted performance measures
Treynor: T = (Ri - r)/ßi
Sharpe S = (Ri - r)/σi
Jensen J = Ri - [r + ßi (Rm - r)]
Pre-specified standard deviation P = Rp - [r +(Rm - r)σi/σm]
Explain the circumstances in which the different risk adjusted measures are appropriate
Circumstances in which different risk - adjusted measures appropriate
- Measure incolving σ are based on capital market line, which applies only to efficient portfolios. So, should be used only when considering entire portfolio
- Measuring involving ß are based on security market line and so can be used in any circumstances ie entire portfolio or part of portfolio
- Jensen and pre-specified standard deviation measures are appropriate if required level of risk is pre-specified
- Unlinked Treynor and Sharpe measures, they cannot be used to compare two managers taking different levels of risk
List the four main reasons for measing the investment performance of a portfolio
- To improve future performance
- Data collected can be used to plannining future strategy
- measuring performance will incenticise fund mangers
- measuring performance will identify strengths and weakness
- To compare rate achieved against target rate
- to compare fund’s performance against
- Others portfolios
- index and or
- Benchmark portfolio
- To appraise and remunerate investment managers
List 6 main limitations and disadvantages of performance management
- Past performance maybe poor guide to future and it may not be easy to distinguish good luck from skill
- difficult to allow for risk
- frequency to allow for risk
- frequency - difficult to strike balance between assessing performance frequency enough to establish and correct problems, and avoiding spurious conclusions based on too short a measure period
- different funds may have different objectives and constraints, so comparisions between such funds may not be valid
- impact on fund manager behaviour - for example, frequent monitoring can encourage short term approach to investment
- cost of measuring performance
State the main advantages and two main disadvantages of assessing performance relative to published indicies
Main advantages
- its relatively easy to do - by definition, data for published indicies is readily available and should be reliably accurate
Main disadvantages
- Available published indices might not be appropriate
- Cant attribute performance to stock and sector selection (as only one sector)
Give two reasons for and two reasons against comparing invesetment performance relative to other portfolios
Reasons
- Appropriate if funds being compared have same objectives and same factors influencing investment strategy
- Gives indication of cost or benefit of following particular strategy, relative to that adopted by other funds
Reasons agaisnt
- Maybe inappropriate to compare performance of funds that have very different investment objectives or constraints (noting that these maynot by public knowledge)
- Relevant data may not be available
State main advantages of assessing performance relative to a benchmarket portfolio
Main advantages of assessing performance
Benchmark portfolio
- Can be constructed to reflect objeectives of fund
- can be construsted in such a way that data necessary for comparisons easily obtained
- that reflects liabilities of funds avoids giving fund manger conflicting objectives
Can attribute performance to stock and sector selection
