Portfolio Management 2: Active Management, Value Added, Risk/Return

Question 1

How do we find active return?

Answer 1

Active return is the difference between the return of our portfolio and the return of the benchmark.

Ra=Rp - Rb

Question 2

When considering the alpha of an active manager, how are we typically measuring risk?

Answer 2

Beta

Question 3

______ is a portfolios risk adjusted value added

Answer 3

Alpha

Question 4

How do we define a portfolio managers active weights?

Answer 4

Active weights of holdings is the difference between the weight in the portfolio and the weight in the benchmark

Active Weight = Wp - Wb

Question 5

The sum product of a portfolio managers active weights and active returns is known as the ____ _____

Answer 5

Value added

Question 6

What are the two main areas in which we will find a portfolio manager gaining active return?

Answer 6

Think PA3. We mainly see managers getting active return in sector allocations and/or security selection

Question 7

We can show risk and return in relative or absolute terms. When thinking about sharpe vs IR, which shows which?

Answer 7

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

Question 8

___ _____ measures a portfolios excess return per unit of risk.

Answer 8

Sharpe Ratio

Question 9

For the sharpe ratio, risk is measured by the _____ _____ of portfolio returns

Answer 9

For the sharpe ratio, risk is measured by the standard deviation of portfolio returns. This is also called the total risk or total volatility

Question 10

What is the equation for the sharpe ratio.

Answer 10

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)

Question 11

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

Answer 11

Ex ante we would have to use expected return. Ex post, we already have the data, so we can use real returns

Question 12

Is the sharpe ratio affected by addition of cash and/or leverage in the portfolio?

Answer 12

Nope

Question 13

___ ___ measure the active risk from a portfolio relative to a benchmark per unit of active risk (aka tracking risk)

Answer 13

Information ratio.

Question 14

What measurement do we use to evaluate the consistency of active returns?

Answer 14

The information ratio

Question 15

WHat is the equation for IR?

Answer 15

IR = Active Return / Active Risk

= Ra / sd(Ra)

= Rp - Rb / sd(Rp - Rb)

Question 16

If we had a closed index fund, how would the sharpe of the portfolio look compared to the sharpe of the bench?

Answer 16

They would be very similar

Question 17

When looking at a closet index fund, what would we expect to see with the IR?

Answer 17

The IR would be close to 0. It could also be negative because the active return may not cover the management fee

Question 18

We would expect a mkt neutral long/short fund to have a beta of ___, so the IR and Sharpe will be _____

Answer 18

Beta to the mkt should be 0, and the IR and Sharpe should be identical

Question 19

Is active management a zero sum game?

Answer 19

Yes. For one manager to outperform another will respectively underperform

Question 20

If we summed the IR of all actively managed funds for a benchmark, we would expect IR to be _____

Answer 20

0.

Question 21

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?

Answer 21

A negative IR indicated negative active return. So you would be better off investing in the benchmark

Question 22

Is IR affected by the addition of cash or leverage into the portfolio?

Answer 22

Yes, if we add cash we can expect our IR to fall

Question 23

Is IR affected by the magnitude of active weights?

Answer 23

No.

Question 24

Is it true that the higher the IR for an active manager, the higher the sharpe?

Answer 24

Yes

Question 25

When looking at active managers, it would be best to invest in the active manager with the highest/lowest IR

Answer 25

Highest

Question 26

The optimal level of active risk is the level that yields the highest ___ ___

Answer 26

Sharpe ratio