Chapter 18 - Portfolio Monitoring and Performance Evaluation Flashcards
How do active managers try to increase returns (2 methods)?
Selection (consistently selecting undervalued securities) and timing (anticipating market trends)
What is the simplest way of calculating a portfolio’s return?
How does this calculation treat contributions + withdrawals?
( Market value at period end - market value at period beginning - contributions + withdrawals ) / market value at beginning + contributions
Contributions are treated as if they happened at the start of the period and withdrawals at the end
Which rate of return method is mandated by CIRO for investment dealers to use?
Dollar-weighted or money-weighted return
How does the dollar-weighted return method work?
It’s an IRR method that accounts for each cash flow when calculating return by comparing end values to beginning values
How does time-weighted return differ from dollar-weighted return?
It eliminates the effect of portfolio cash flows and measures only the performance of the investments. The idea is that since the IA cannot control the timing of a client’s deposits/withdrawals, the dollar-weighted return is not an appropriate measurement.
How do you calculate a portfolio’s time-weighted return?
Calculate a portfolio’s return from the beginning value to the point where the first cash flow is received, then do that for each subsequent cash flow. Then do 1+R x 1+R etc
Example = 1.08 x 0.95 x 1.10 = 12.86%
What are the 4 classes of benchmark portfolios?
- Composite market indexes
- Investment style benchmarks
- Normal portfolios
- Sharpe benchmarks
What is a sharpe benchmark?
Benchmark constructed by combining a variety of style indexes, created statistically using multiple regression analysis
What is survivorship bias?
A performance index is always a universe of survivors as defunct portfolios are dropped out and excluded from comparison rankings. This can lead to a manager appearing to underperform in the long term due to benchmark creep.
What is the purpose of performance attribution analysis?
To deconstruct a portfolio’s total performance into components that can be associated with particular decisions made by the client and portfolio manager. This can pinpoint how well the manager is doing.
What is a portfolio’s policy return?
The portfolio’s return based on its strategic asset allocation using benchmarks.
What is a portfolio’s allocation return?
The return based on shifting a portfolio’s weights from its strategic asset allocation.
What is the allocation effect?
The difference between a portfolio’s allocation return and policy return, a measurement of how tactical allocation shifts (away from the strategic asset allocation) either provide a benefit or disadvantage for a portfolio.
What is a portfolio’s selection effect?
A measurement of a PM’s ability to select individual securities,
What are the (3) risk-adjusted return measures?
- Jensen’s alpha
- Treynor ratio
- Sharpe ratio
What is Jensen’s alpha?
Quantifies the degree to which a manager has added value relative to the market given a portfolio’s systematic risk.
How do you calculate Jensen’s alpha?
Portfolio’s return minus the risk-free return - (Beta x (Avg market index return - risk free rate))
What does a positive Jensen’s alpha indicate?
The PM has produced more return than predicted by the beta, thus adding value to the portfolio.
What is the Treynor ratio?
Also called Treynor’s reward-to-volatility ratio, it’s a measure of the average excess return per unit of risk.
How do you calculate the treynor ratio?
(Portfolio’s return - risk free rate ) / beta
What does a high treynor ratio imply?
The higher the ratio, the better the PM performed. This is intended to be compared with other treynor ratios from other funds.
What is the sharpe ratio?
The reward-to-variability ratio. Similar to the treynor ratio except it uses standard deviation as its risk measure (rather than beta).
How do you calculate sharpe ratio and how does this differ from the treynor ratio?
Return - risk free rate / standard deviation.
Treynor ratio uses beta as the denominator instead of stdev.
Why does the sharpe ratio effectively penalize poor diversification?
Total risk (standard deviation) includes bot systematic and unsystematic risk. If the portfolio is not well diversified, it will have a lot of unsystematic risk, resulting in a large total risk.
