Performance evaluation Flashcards
Monte Carlo Simulation
Monte Carlo model assumes a simple average return and a standard deviation of returns for the portfolio, whereas the deterministic model assumes linear portfolio growth. Both models should use forward-looking capital market assumptions
Performance attribution: Selection / Interaction / Allocation effect
Allocation effect = (portfolio weight - benchmark weight)(benchmark return - total benchmark return)
Selection effect = benchmark weight(portfolio return− benchmark return)
Interaction effect = (portfolio weight − benchmark weight)(portfolio return - benchmark return)
Efficient frontier graph: Corner portfolios
Corner portfolios are efficient portfolios and represent a portfolio where an asset weight changes from zero to positive or positive to zero. The Sharpe ratio is the slope of the line drawn from the risk-free rate to a particular portfolio.
In mean–variance optimization models, the inclusion of illiquid assets in the eligible investment universe may shift the efficient frontier for their portfolio upwards, theoretically resulting in greater efficiency (i.e., higher expected returns will be gained across all given levels of risk).
Rebalancing corridor
When an asset class exhibits a lower correlation with the rest of the portfolio, the rebalancing range should be narrower, to preserve its contribution to risk reduction. The higher the correlation of an asset class with the rest of the portfolio, the wider the optimal corridor. When asset classes move in sync, further divergence from target weights is less likely.
The lower the volatility of an asset class relative to the rest of the portfolio, the wider the optimal rebalancing corridor.
The low transactions costs associated with the global fixed-income asset class means that rebalancing will be less costly, justifying a narrower rebalancing corridor
After-tax rebalancing range = Pre-tax rebalancing range/(1 – Tax rate).
performance evaluation = performance measurement, performance attribution, and performance appraisal.
performance evaluation = performance measurement, performance attribution, and performance appraisal.
Liquidity-seeking algorithms
Liquidity-seeking algorithms are appropriate for large orders that the portfolio manager or trader would like to execute quickly without having a substantial impact on the security price.
risk parity asset allocation
A risk parity asset allocation is based on the notion that each asset class should contribute equally to the total risk of the portfolio. Bonds have the lowest risk level and must contribute 25% of the portfolio’s total risk, so bonds must be overweighted
Tracking error of ETF
ETF would have associated tracking error, which may result from premiums and discounts to net asset value, cash drag, or regulatory diversification requirements.
ETF
establish a 1.2% long position to the S&P 500 Index using short-term S&P 500 futures
Execution in the derivatives market offers the following advantages:
• Quick implementation
• Flexibility to tactically adjust exposure and quickly reverse decisions
• Ability to leave external managers in place
• High levels of liquidity
views the sell-off as temporary and is pleased with external manager performance. This suggests a short-term rebalancing approach is warranted rather than reallocating amongst managers. Execution in the derivatives market will enable quick rebalancing while leaving current allocations in place.
While derivatives can present tracking error and operational risks, the expected short-term nature of the rebalancing serves to contain their effects. The benefits to be gained using derivatives appear to more than outweigh the associated cost and risk
Incentive fee / performance fee
incentive fees are fees charged as a percentage of returns (reducing net gains in positive months and reducing net losses in negative months), its use lowers the standard deviation of realized returns.
Performance based fee: drawbacks
Tension can be created between the client and PM, as the client must pay base fees even if Pourtir underperforms.
Pourtir’s fee structure may lead to misestimates of portfolio risk and may incentivize Pourtir to assume higher portfolio risk.
The client and Pourtir may have different incentives when performance-based fees are used, specifically in the case of bonus-style fees.
Performance-based fees may incentivize Pourtir to hold on to assets until a profit can be realized even if the client would benefit from selling the assets at a loss and investing the proceeds elsewhere.
Bonus-style fees ~ call option on manager’s active return
Bonus-style fees are the close equivalent of a manager’s call option on a share of active return, for which the base fee is the strike price—for example, the 18 bps base fee, plus a long call option on active return with a strike price equal to the minimum (base) fee, minus another (less valuable call option) with a strike price equal to the maximum fee.
