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
+The rate is independent of the amount and timing of cashflows into the fund
- The calculation requires the fund values at the time of each cashflow
- The calculation does not provide the actual rate earned by the fund
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 value at various dates throughout year
+calculating the internal rate of return for each intervaluation period
+linking inter - valuation rates of return to get linked internal rate of return
Get close approximation to TWRR if
+Short intervaluation periods are used or
+Valuations occur close to dates of casfhlows or
+Cashflows are small 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 initial value of portfolio and subsequent net new money been invested in same way as index
+Compare the time weighted return or (LIRR) from each
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 defined in some other, predetermined way
+need to allow carefully for income, net new money, re-balancing, tax and expense
Explain how to split the overall out performance 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 measuring the investment performance of a portfolio
+To improve future performance
Data collected can be used to plan future strategy
measuring performance will incentive 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 indices
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 investment 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 against
+Maybe inappropriate to compare performance of funds that have very different investment objectives or constraints (noting that these may not by public knowledge)
+Relevant data may not be available
State main advantages of assessing performance relative to a benchmark portfolio
Main advantages of assessing performance
Benchmark portfolio
+Can be constructed to reflect objectives of fund
+Can be constructed in such a way that data necessary for comparisons easily obtained
+reflects liabilities of funds avoids giving fund manger conflicting objectives
Can attribute performance to stock and sector selection
