Performance Analysis Flashcards
What is meant by a funds alpha? (4)
- the difference between expected return and actual return
- return not explained by market movements and beta
- risk adjusted return measure
- value added by the fund manager
- amount of return not accounted for by its beta
Alpha formula
Alpha = actual return - CAPM
Alpha = actual return - [Rf + Bi(Rm-Rf)]
Rf = risk free return Rm = market return Bi = beta of fund
What is beta?
- measures the risk of a fund compared to the rest of the market
What is meant by value investing and the assumption which underpins the concept (3)
- identifies stock which are undervalued/ trading at less…
- than their intrinsic value
Assumptions:
- the market is inefficient
- but will return to fair value
Explain How is technical analysis used to make investment decisions (4)
- based only on share price/ excludes fundamental analysis (company accounts etc)
- uses charts of past share price
- identifies patterns that predict future performance
- assumes these are repeated
What does information ratio measure and it’s limitations (6)
- relative performance
- compared to a benchmark
- adjusted for risk
Limitations:
- based on historical data
- needs to be compared to similar funds
- need to look at trends
- need to consider other factors
Information ratio formula
(Investment return - index or benchmark return) / tracking error
Measures risk adjusted returns vs benchmark
Reasons why funds with same benchmark have different information ratios (3)
- different tracking errors
- different performances
- different portfolio construction
What is tracking error?
tracking error or active risk is a measure of the risk in an investment portfolio that is due to active management decisions made by the portfolio manager.
it indicates how closely a portfolio follows the index to which it is benchmarked.
Explain potential causes of an ETF tracking error (7)
- inaccuracy of the method used
- management fees
- other costs
- currency hedging
- cash drag
- dividend reinvestment lag
- tax
- securities lending
Purpose of using a benchmark (4)
- sets assets allocation/ starting point
- Independant basis
- to manage risk expectations
- to measure relative performance to benchmark / value added by fund manager
Why include an asset in a portfolio which has lost money over the last 5 years (4)
- diversification
- negatively correlated to other assets
- lower volatility (if bonds or cash)
- better expected risk adjusted returns
- past performance no guide to future
Money weighted return:
What does it show?
What is the formula?
MWR measures overall return on capital over a specific period
= difference in value + income/capital distributions
R = [D + (V1 - V0)] / V0
V1 = value at end V0 = value st start D = income/ capital distributions
Sharpe ratio
- what does it show?
- what is the formula?
- measure of risk adjusted returns of an investment
- measures excess returns for every unit of risk taken
- uses to compare investments to see which offers most return for any given level of risk
- allows comparison
- if returns of different funds
- adjusted for risk
SR = (return on investment - Rf return) / SD
Difference between return on investment and Rf = excess return for taking the risk
- risk is measured by SD
If SR = 0.75 then 0.75% extra return for each unit of risk taken
The higher the SR the better the returns for the amount of risk taken
Negative SR shows Rf would have been better
SR is useful to measure if returns are due to fund manager decisions or purely because of extra risk being taken
Limitations of the sharper ratio (4)
- returns are not always normally distributed
- assumes that SD is correct measure of risk
- assumes risk free return rate is correct
- simplistic / ignores other factors
- ignores Charges
- ignores tax
- uses historic data
- can be manipulated
