Portfolio Management #54 - Analysis of Active Portfolio Management Flashcards

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1
Q

required qualities of a benchmark portfolio

A

LOS 54.a

  1. representative - must represent the universe from which the active portfolio manager selects securities
  2. inexpensively replicable
  3. predictable - benchweights are known ex-ante (in the future)
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2
Q

expected active return (“value added”)

A

LOS 54.a

E(RA) = E(RP) - E(RB)

E(RA) = sum(i=1,N) d(wi) * E(Ri), where

d(Wi) = active weight = wPi - wBi

  • can be computed ex-ante (forecasted) or ex-post (historically)
  • positive active returns generated by overweighting assets with higher expected returns and underweighting those with lower expected returns
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3
Q

risk-adjusted active return

A

LOS 54.a

risk-adjusted: alpha →aP = RP - ßPRB

All discussion in this reading assumes that systematic risk of benchmark and managed portfolio is the same i.e. ßP = 1, where ßP is portfolios level of systematic risk compared the benchmark B

risk-adjusted: alpha →aP = RP - RB

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4
Q

Sharpe ratio, information ratio

A

LOS 54.b

Sharpe ratio: SR = (Rp - Rf) / σp

information ratio: IR =(Rp - Rb) / σ(Rp-Rb) = RA / σA

= active return / active risk

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5
Q

qualities and differences between Sharpe and Information ratio

A

LOS 54.b

Sharpe ratio (SR):

  • SR is unaffected by adding cash or leverage to the portfolio

information ratio (IR):

  • is affected by adding cash or leverage
  • ex-ante IR is always positive
  • ex-post IR can be postive or negative
  • IR of unconstrained portfolio is unaffected by agressiveness of the active weights
  • combining active and benchmark portfolios into one portfolio will have same IR as the active portfolio by itself
  • weights to fund with zero systematic risk (e.g. mkt neutral) that has Rf as its benchmark: SR = IR
  • investor’s active risk can be reduced by combining active and benchmark portfolio weights in proportion to desired active risk
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6
Q

closet index fund

A

LOS 54.b

closet index fund - fund claiming to be actively managed but closely tracks its benchmark index

  • tends to have same Sharpe (SR) as benchmark
  • tends to have very low info ratio (IR) as benchmark
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7
Q

Fundamental Law of Active Management

3 factors that determine the information ratio (IR)

A

LOS 54.c

information coefficient (IC) - measure of mgr’s skill

  • ex-ante: expected correlation between active returns and forecasted active returns
  • ex-post: (ICR) measures actual correlation between active returns and expected active returns, usually a small + value (< 0.2)

transfer coefficient (TC) - correlation between actual active weights dWi and optimal active weights dWi*

  • TC = for unconstrained portfolios
  • TC < 1 w/ constraints: dWi and Wi*will differ

breadth (BR) - number od independent bets (forecasts of active return)

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8
Q
A
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