Investments Topic 13 - Assessing Investment Performance

Question 1

3 basic investment performance measures:

Answer 1

• Time value of money
• Compounding and discounting
• Real and nominal returns

Question 2

Holding period return (or money-weighted return)

Answer 2

a way to express the total investment return provided from income and growth during the holding period

Question 3

Calculation for holding period percentage

Answer 3

Question 4

Money-weighted rate of return

Answer 4

more complex calculation that allows investor to assess return over a period where capital has been withdrawn from the investment during the period.

Question 5

Time-weighted rate of return (TWR)

Answer 5

measures the compound rate of return for a unit of money over a given period. It breaks down the returns assuming that money will be added and subtracted from investments.

Question 6

3 ways risk-adjusted returns can be shown

Answer 6

alpha, Sharpe ratio and information ratio

Question 7

key features of Alpha

Answer 7

• Used to measure risk-related return on a particular share or collective fund compared with a benchmark
• Measure difference between actual and expected return
• A share’s alpha measures how much that security will move during a period where the benchmark does not move

Question 8

Sharpe ratio:

Answer 8

• Defined as the additional return per unit of risk compared with a risk-free investment
• Calculated as (return – risk-free return) / standard deviation
• Illustrates how well the return from an investment compensates the investor for the risks taken

Question 9

Advantages of using Sharpe ratio over alpha

Answer 9

• Because it doesn’t use beta it is more reliable, standard deviation is more accurate than beta
• Sharpe allows for comparison of different types of security, whereas alpha and beta use specific benchmarks etc.

Question 10

Information ratio:

Answer 10

• Essentially an adapted Sharpe ratio, but uses any appropriate benchmark rather than a risk-free rate
• IR is calculated by deducting the annual benchmark return from the average annual share, then dividing by the tracking error
• The higher the IR, the better the performance

Question 11

Tracking error

Answer 11

a measure of how closely a fund follows its benchmark

Question 12

Stock market indices can be helpful for:

Answer 12

• Comparing performance of specific share/sector
• Identifying potential future trends
• Can compare fund performance with market/benchmark
• Observation of general economic activity

Question 13

Main stock market indices

Answer 13

• FTSE 100
• FTSE All-Share
• Dow Jones Industrial Average
• NASDAQ Composite Index
• Nikkei 225

Question 14

FTSE 100:

Answer 14

• Index comprises of 100 biggest UK companies by share capitalisation
• Updated during the day every day (real-time index)
• Represents around 81% of total market capitalisation
• Market-capitalisation weighted index – instead of every company representing 1%, they are weighted by their market capitalisation
• This means that shifts in the bigger companies have a bigger effect on the index

Question 15

FTSE All-Share

Answer 15

• Represents around 99% of the UK market capitalisation with 38 different market sectors
• Uses all the companies from the FTSE 100, 250 and FTSE Small Cap Indices
• Not a real-time index, calculated at the end of every business day

Question 16

Dow Jones Industrial Average:

Answer 16

• Consists of the 30 largest and most widely held blue chip companies on the NY stock exchange

Question 17

NASDAQ Composite Index:

Answer 17

• Comprises of 3000 companies listed on the NASDAQ stock market
• Seen as a good indicator of the technology sector because it has more than 50% weighting in technology stocks

Question 18

Nikkei 225

Answer 18

• Index to Tokyo stock exchange and is unweighted on the average price of 225 Japanese stocks

Question 19

Downsides of indices:

Answer 19

• Weighted index means that a few large companies can affect the whole index
• Very few indices include dividend income, underestimating the total returns
• The figures take no consideration of costs and tax

Question 20

Performance attribution

Answer 20

how well a fund manager has performed while taking part in ‘active investment’.

Question 21

4 key factors that will affect a fund manager’s ability to add value to a fund

Answer 21

• Asset allocation
• Stock selection
• Market timing
• Risk

Question 22

Peer group

Answer 22

another fund that can be compared with said fund providing that it is similar in its objectives and styles.