TOPIC 9 - PERFORMANCE EVALUATION

Question 1

The simplest performance measure compares average return

Answer 1

to that on a benchmark such as an appropriate market index or even the median return of funds in a comparison universe.

Question 2

alternative performance measures of the average return incl.

Answer 2

arithmetic and geometric average and time-weighted vs dollar weighted returns

Question 3

appropriate performance measure depends on the

Answer 3

role of the portfolio to be evaluated.

Question 4

Use Sharpe ratio as a performance measure where:

Answer 4

portfolio represents entire investment fund

Question 5

Use Information ratio as a performance measure where:

Answer 5

when portfolio represents the active portfolio to be optimally mixed with the passive portfolio

Question 6

Use Treynor as a performance measure where:

Answer 6

when the portfolio represents one subportfolio of many

Question 7

Use Jensen (alpha) as a performance measure where:

Answer 7

all of these measures require a positive alpha for the portfolio to be considered attractive

Question 8

Many observations and long sample periods are required to eliminate the effect of the “luck of the draw” from the evaluation process because:

Answer 8

because portfolio returns are commonly very “noisy”

Question 9

Style analysis uses a multiple regression model where the factors are

Answer 9

category (style) portfolios such as bills, bonds and stocks.

Question 10

The coefficients on the style portfolios indicate

Answer 10

a passive strategy that would match the risk exposures of the managed portfolio.

Question 11

Shifting mean and risk of actively managed portfolios make it difficult

eg

Answer 11

to assess performance. An important eg of this problem arises when portfolio managers attempt to time the market, resulting in ever changing portfolio betas.

Question 12

One way to measure timing and selection success simultaneously is to

Answer 12

estimate an expanded SCL for which the slope (beta coefficient) is allowed to increase as the market return increases

Question 13

Another way to evaluate timers is based on the

Answer 13

implicit call option embedded in their performance.

Question 14

Common attribution procedures decompose portfolio performance to

Answer 14

asset allocation, sector selection and security selection decisions.

Question 15

With common attribution procedures, how is performance assessed?

Answer 15

by calculating departures of portfolio composition from a benchmark or neutral portfolio.

Question 16

the greater the volatility, the lower or higher the geometric average comparative to the arithmetic average

Answer 16

the lower the geometric average comparative to the arithmetic average

Question 17

Geometric average is a

Answer 17

time-weighted average –> each period’s return has equal weight

Question 18

dollar weighted returns are the same as the

Answer 18

internal rate of return

Question 19

Internal rate of return can be found from

Answer 19

the DCF approach
PV = C1/(1+r)^1 + C2/(1+r)^2 ….+Cn/(1+r)^n

if you know PV and CFs you can calculate r (which is the IRR)

Question 20

Simplest and most popular way to adjust for risk is to

Answer 20

compare rates of return with those of other investment funds with similar risk characteristics

Question 21

if the only risky asset held by the investor is shares what risk adjusted performance measure do you use

Answer 21

Sharpe ratio (divides average portfolio excess return over the sample period by the SD of the returns over that period) –> measures reward to total volatility trade off

Question 22

If the stock is one of many stocks that the investor is analysing to form an actively managed stock portfolio what risk adjusted performance measure do you use?

Answer 22

Treynor’s measure: ratio of average portfolio excess return over sample period to SYSTEMATIC RISK over that period (uses systematic risk instead of total risk)

Question 23

If the stock is mixed with the market index fund then the contribution to the overall Sharpe measure is determined by

Answer 23

the information ratio

divides alpha of portfolio by portfolio’s non-systematic risk

Question 24

what does the information ratio measure

Answer 24

abnormal return per unit of risk that in principle could be diversified away by holding a market index portfolio

Question 25

Alpha is often referred to as “excess return” or “abnormal rate of return,” which refers to the idea

Answer 25

that markets are efficient, and so there is no way to systematically earn returns that exceed the broad market as a whole.

Question 26

Alpha is often used in conjunction with beta which measures

Answer 26

the broad market’s overall volatility or risk, known as systematic market risk.

Question 27

Jensen’s alpha takes into consideration

Answer 27

the CAPM and includes a risk-adjusted component in its calculation.

Question 28

What’s the M^2 measure?

Answer 28

focuses on the total volatility as a measure of risk but its risk adjustment leads to an easy to interpret differential return relative to the benchmark index

Question 29

survivorship bias

Answer 29

occurs when only the winners are considered while the losers that have disappeared are not considered.

This can occur when evaluating mutual fund performance (where merged or defunct funds are not included) or market index performance (where stocks that have been dropped from the index for whatever reason are discarded).

Question 30

Survivorship bias skews the average results

Answer 30

upward for the index or surviving funds, causing them to appear to perform better since underperformers have been overlooked.

Question 31

Style analysis a tool to do what?

Answer 31

systematically measure the exposures of managed portfolios introduced by Sharpe

Question 32

what is the idea behind style analysis?

Answer 32

to regress fund returns on indexes representing a range of asset classes

–> Regression coefficient on each index would then measure the fund’s implicit application to that ‘style’

–> R2 of regression would measure % of return variability attributable to style choice rather than security selection

Question 33

Performance attribution studies attempt to decompose overall performance into

Answer 33

discrete components that may be identified with a particular level of the portfolio selection process

Question 34

simply put return on a stock over a year =

Answer 34

(capital gains + dividend)/price

= (P1-P0+ dividend)/P0

Question 35

alpha is what intercept

Answer 35

the regression intercept (aka set beta =0)

Question 36

does the sharpe ratio use systematic risk or total risk?

Answer 36

total risk (treynor’s measure pretty similar to sharpe only dif is that treynor’s just measures systematic risk, aka beta)

Question 37

how to determine the contribution of security selection relative to performance

Answer 37

take the difference in returns (aka manager’s returns for the asset class - index’s returns) x manager’s portfolio weight for that asset class

Question 38

differential return within market (manager returns - index) x manager’s portfolio weight of each asset class =

Answer 38

contribution of security selection to performance

Question 39

contribution of asset allocation relative to performance

Answer 39

excess weight x index return

aka

(manager’s weight - benchmark weight) x index return

Question 40

calculation of secrutiy selection contribution relative to performance + asset allocation contribution relative to performance =

Answer 40

excess performance

Question 41

what does within sector selection effect?

Answer 41

The within sector selection calculates the return according to security selection. This is done by summing the weight of the security in the portfolio multiplied by the return of the security in the portfolio minus the return of the security in the benchmark

Question 42

if a passive managed fund mimics the benchmark index, then will the R^2 of the regression be high or lower than that of an actively managed fund when looking at return-based style analysis

Answer 42

Because the passively managed fund is mimicking the benchmark, the R2 of the regression should be very high (and thus probably higher than the actively managed fund).

Question 43

M^2 measure:

Answer 43

[(SD_m/SD_p)x r_p] + [(1-SD_m/SD_p)x rf ] - r_m