Portfolio Management 2: Active Management, Value Added, Risk/Return Flashcards
How do we find active return?
Active return is the difference between the return of our portfolio and the return of the benchmark.
Ra=Rp - Rb
When considering the alpha of an active manager, how are we typically measuring risk?
Beta
______ is a portfolios risk adjusted value added
Alpha
How do we define a portfolio managers active weights?
Active weights of holdings is the difference between the weight in the portfolio and the weight in the benchmark
Active Weight = Wp - Wb
The sum product of a portfolio managers active weights and active returns is known as the ____ _____
Value added
What are the two main areas in which we will find a portfolio manager gaining active return?
Think PA3. We mainly see managers getting active return in sector allocations and/or security selection
We can show risk and return in relative or absolute terms. When thinking about sharpe vs IR, which shows which?
Sharpe shows absolute expected (ex ante) or realized (ex post) risk/return measure
IR shows a relative to bench ex ante or ex post risk/return measure
___ _____ measures a portfolios excess return per unit of risk.
Sharpe Ratio
For the sharpe ratio, risk is measured by the _____ _____ of portfolio returns
For the sharpe ratio, risk is measured by the standard deviation of portfolio returns. This is also called the total risk or total volatility
What is the equation for the sharpe ratio.
We find the sharpe ratio by taking the difference between the portfolio and the bench, and dividing it by the standard deviation of the portfolio returns.
SRp = Rp - Rb
________
STD (Rp)
Considering ex ante and ex post: When incorporating returns into our equations, when will we use expected return and when will we use real return
Ex ante we would have to use expected return. Ex post, we already have the data, so we can use real returns
Is the sharpe ratio affected by addition of cash and/or leverage in the portfolio?
Nope
___ ___ measure the active risk from a portfolio relative to a benchmark per unit of active risk (aka tracking risk)
Information ratio.
What measurement do we use to evaluate the consistency of active returns?
The information ratio
WHat is the equation for IR?
IR = Active Return / Active Risk
= Ra / sd(Ra)
= Rp - Rb / sd(Rp - Rb)
If we had a closed index fund, how would the sharpe of the portfolio look compared to the sharpe of the bench?
They would be very similar
When looking at a closet index fund, what would we expect to see with the IR?
The IR would be close to 0. It could also be negative because the active return may not cover the management fee
We would expect a mkt neutral long/short fund to have a beta of ___, so the IR and Sharpe will be _____
Beta to the mkt should be 0, and the IR and Sharpe should be identical
Is active management a zero sum game?
Yes. For one manager to outperform another will respectively underperform
If we summed the IR of all actively managed funds for a benchmark, we would expect IR to be _____
0.
If you’re looking at an active manager, and you see that ex-post IR is negative, should you invest in the manager or the benchmark?
A negative IR indicated negative active return. So you would be better off investing in the benchmark
Is IR affected by the addition of cash or leverage into the portfolio?
Yes, if we add cash we can expect our IR to fall
Is IR affected by the magnitude of active weights?
No.
Is it true that the higher the IR for an active manager, the higher the sharpe?
Yes
When looking at active managers, it would be best to invest in the active manager with the highest/lowest IR
Highest
The optimal level of active risk is the level that yields the highest ___ ___
Sharpe ratio
