Chap 23

Question 1

It quantifies the degree to which a manager has added value relative to the market given the portfolio’s systematic risk.

Answer 1

Jensen’s alpha

Question 2

It measures the performance of the portfolio as experienced by the investor.

Answer 2

dollar-weighted return

Question 3

These are the best-known type of benchmark portfolios. They are designed to measure the movements of specified markets, rather than benchmark performance.

Answer 3

composite market index

Question 4

It is the collection of portfolios (share similar risk characteristics) that form the basis for comparison in performance evaluation.

Answer 4

comparison/performance universes

Question 5

The primary purpose of this is to set a realistic, attainable performance standard.

Answer 5

benchmark portfolio

Question 6

Sharpe Benchmark

Key Concepts:

Answer 6

1. Statistical Creation:
   • Method: Multiple-regression analysis
   • Purpose: Identifies if success is due to good management or high risk
2. Performance Measurement:
   • Comparison: Against various indexes
3. Style Analysis:
   • Function: Classifies manager’s typical investment style
4. Reduce Style Drift:
   • Goal: Ensures manager sticks to intended investment style

Visual Summary:

•	**Multiple-Regression Analysis:**
•	🧮 Statistical Method
•	🎯 Goal: Good Management vs. Excessive Risk
•	**Performance Measurement:**
•	📊 Against Indexes
•	**Style Analysis:**
•	🧐 Classifies Investment Patterns
•	**Reduce Style Drift:**
•	🚦 Maintains Consistent Style

Question 7

It is a measure of the average excess return per unit of risk. Risk is measured by the portfolio’s beta.

Answer 7

Treynor ratio

Question 8

It involves the calculation of the return realized by a portfolio over a specific period.

Answer 8

Performance measurement

Question 9

It is a specialized benchmark that includes all the securities that a manager normally selects from.

Answer 9

normal portfolio

Question 10

It measures the excess average return per unit of total risk for a given period. Total risk is measured as the standard deviation of returns.

Answer 10

Sharpe ratio

Question 11

It measures only the cumulative performance of the portfolio’s investments.

Answer 11

time-weighted return

Question 12

It is an assessment of how well a portfolio has done over the evaluation period.

Answer 12

Performance appraisal

Question 13

An effective monitoring system should (at a minimum) do the following:

Answer 13

1. Keep the client’s financial information up to date.
2. Keep the client’s contact information up to date.
3. Describe how often meetings will as per the investment policy statement
   (IPS), which is created and agreed to by the client and advisor.
4. Allow the advisor to stay on top of economic and financial market trends.
5. Monitor the performance of fund managers if managed accounts are being used.
6. Conduct periodic reviews and ask clients if their financial goals or personal circumstances have changed since the last review. Reviews should be held at least annually, and in some cases, quarterly.

Question 14

Performance measurement and performance appraisal when looked at together will provide a ___________ of the advisor’s recommendations and how the client did.

Answer 14

cost-benefit analysis

Question 15

Most firms have in-house software that will generate client portfolio reports with the following information:

Answer 15

• list of the securities held in the portfolio.
• adjusted cost base (ACB) aka book value of each security.
• the security’s weighting in the portfolio (based on current market value)
• each security’s dividend or interest rate along with the annual dollar income and the current yield.

Question 16

Measuring Portfolio Returns when there are no cash flows (in or out) during the measurement period

Answer 16

Holding period return = (Ending value - Beginning value) / (Beginning value)

Question 17

Measuring Portfolio Returns when there are cash flows (in or out) during the measurement period

Answer 17

Holding period return = (Ending value - Beginning value - Net contributions) / (Beginning value + Contributions)

Question 18

notes on holding period return formulas:

Answer 18

1. not an exact return if there are cash flows (assumptions made)
   - contributions @ beginning
   - withdrawals @ end
2. Instead dollar-weighted and time-weighted returns generally used
3. calculates return over entire holding period (could be one day or many decades)

Question 19

IIROC requires investment dealers to give clients their annualized returns using the ________________

Answer 19

dollar-weighted return (money-weighted return or internal rate of return)

Question 20

_____________ measures the performance of a portfolio, taking into account the amount and timing of cash flows (additional contributions or withdrawals)

Answer 20

dollar-weighted return

Question 21

___________ removes the cash flows from the calculation and determines the return for each period from just after the last contribution (or withdrawal) to just before the next contribution (or withdrawal)

Answer 21

Time-Weighted Return

Question 22

How to “follow the dollar”

Answer 22

To calculate the return over the entire period, we use a process called “follow the dollar”, where we pretend that one dollar was invested, and we see how much it would grow using the internal rate of return (IRR) that we already calculated.

Question 23

Remember, with __________, you do not directly include the contributions or withdrawals in the formula because they are already accounted for in the “Portfolio Value Immediately After the Contribution (Beginning)”

Answer 23

time-weighed return

Question 24

Calculate time-weighted return (step 2)

Answer 24

Question 25

Calculate time-weighted return (step 1)

Answer 25

Question 26

A good benchmark should be the following:

Answer 26

* **Investable** The client should be able to invest in the securities that make up the benchmark index * **Unambiguous composition** The securities that make up the benchmark portfolio must be clearly identified. * **Appropriate** The benchmark must have a similar risk level to the client's portfolio and be consistent with the manager's investment style. * **Attainable** The advisor must be able to invest in all benchmark securities for the client. * **Objectively constructed** The benchmark must be built using objective rules, so it is not lopsided either for or against the advisor. * **Specified in advance** The benchmark must have existed before the start of the evaluation period. * **Easily measurable** (self-explanatory)

Question 27

Problems with benchmarking

Answer 27

1. unless **rebalanced regularly** investment style will drift and become inappropriate for benchmarking 2. temptation to become a **closet indexer** 3. **temptation to deviate to out-perform** (unfair to other who don't deviate from SAA) 4. **fees may impact return** and render benchmark an unfair comparison 5. money managers **need to hold cash** (for redemptions and investment opportunities) but benchmarks don't

Question 28

Classes of Benchmark Portfolios

Answer 28

1. Composite market indexes 2. Investment-style benchmarks 3. Normal portfolios 4. Sharpe benchmarks

Question 29

A __________ primary purpose is to be a realistic, attainable performance standard that will allow the performance of an investor's portfolio with a similar asset allocation to be compared against it.

Answer 29

benchmark portfolio's

Question 30

Composite Market Indexes

Answer 30

• Indexes that are designed to measure the movement of specific markets. An example would be the S&P/TSX Composite Index.

Question 31

Investment-Style Benchmarks

Answer 31

• These benchmarks reflect the performance of a certain style of security. An example would be an index that tracks only small-cap stocks.

Question 32

Problems with comparison/performance universes

Answer 32

1. **poorly defined** 2. **poor job accounting for risk** 3. **difficult to partition fixed-income** universes (find close benchmark) 4. **returns gross of management fees** (gross return can be misleading due to varying management fees) 5. may be **survivorship bias**

Question 33

_____________ happens when comparing the return of a fund to its peers. You are comparing the fund only to the survivors, which are the very best funds that have survived the long haul.

Answer 33

survivorship bias

Question 34

Risk-Adjusted Returns

Answer 34

The success of a portfolio manager is determined by comparing the return of the portfolio he or she manages to that of comparable portfolios. When evaluating performance, it is **critical that the risk assumed be factored into the assessment**. For example, if T-bills (considered a risk-free investment) earned 4% and a manager who accepted lots of risk earned only 4.25%, the question must be asked "Was the increased return worth the much higher risk taken to earn that extra 0.25%?"

Question 35

When evaluating the risk-adjusted return on a portfolio, the ___________________ is the preferred measure.

Answer 35

Sharpe Ratio

Question 36

The __________________ measures the return per unit of risk in a portfolio.

Answer 36

Sharpe ratio

Question 37

Sharpe ratio formula

Answer 37

Sharpe ratio = (Return on portfolio - Risk-free rate) / Standard deviation All else being equal, the higher the Shape ratio the better because a higher ratio means you are getting more return for the risk you are taking.

Question 38

All else being equal, the ________ the Shape ratio the better

Answer 38

higher (because a higher ratio means you are getting more return for the risk you are taking)

Question 39

How much risk the manager assumes is measured by _______________

Answer 39

standard deviation

Question 40

_______ is a measure of the value that a fund manager adds to the performance of his or her fund

Answer 40

Alpha

Question 41

If alpha is __________, the manager added value. If the fund manager has under-performed expectations (did not add value), the alpha is ____________.

Answer 41

positive, negative

Question 42

To calculate the ______________ of a portfolio, use Jensen's alpha (CAPM Alpha)

Answer 42

risk-adjusted expected return

Question 43

CAPM Alpha (aka Jensen's alpha) Formula

Answer 43

CAPM Alpha (aka Jensen's alpha) = Actual return - CAPM expected return To calculate alpha, all you have to do is compare the actual return to the risk-adjusted expected return, and the difference is Alpha

Question 44

At the end of the year, a portfolio achieved an actual return of 13.5%. The portfolio's beta was 1.20. The Canadian equity market has historically returned 9%. The rate on 90-day T-bills (the risk-free rate) during the measurement period was 4%. Did the fund manager add value, and if so, how much? First, we must determine the ________________ using the three-step process.

Answer 44

CAPM expected return of the portfolio

Question 45

How to calculate **CAPM expected return of the portfolio** (3 steps)

Answer 45

Step 1: Deduct the risk-free rate from the market rate. Step 2: Multiply the remaining variable by beta. Step 3: Add the risk-free rate back in. Step 1: 9% - 4% = 5% Step 2: 5% x 1.20 = 6% Step 3: 6% + 4% = 10% Therefore, the expected return of the portfolio using the CAPM is 10%.

Question 46

Treynor Ratio (Also Known as "___________________")

Answer 46

Reward-to-Volatility Ratio

Question 47

The _____________ the Treynor ratio the better.

Answer 47

higher

Question 48

The __________________ uses beta (systematic risk) as the measure of risk (i.e. beta is on the bottom of the formula)

Answer 48

Treynor ratio

Question 49

The ______________ uses standard deviation as the measure of risk (i.e. standard deviation is on the bottom of the formula).

Answer 49

Sharpe ratio

Question 50

Both Treynor and Jensen (CAPM) use _______ as the measure of risk in the formula.

Answer 50

beta

Question 51

The Treynor ratio may differ from Jensen (CAPM) in the ranking of different portfolios due to ____________________.

Answer 51

due to the manner in which they incorporate risk. - while both methods would agree as to whether a portfolio out-performed or underperformed the market portfolio, **how well it** out-performed or under-performed may differ depending on which method is used.

Question 52

Client (Account) Statements must be sent:

Answer 52

**Monthly** whenever a transaction (purchase/sale of a security, or a contribution/withdrawal from an account) **Quarterly** for all customers having either a credit balance (cash and/or securities held within the account) or a debit balance.

Question 53

Receiving regular interest or dividends does not in itself require a monthly statement to be sent out. However, the _________________ would!

Answer 53

reinvesting of that money

Question 54

Issues in Performance Evaluation *Whether returns are reported prior to or after fees is an important observation to make when ____________.

Answer 54

analyzing returns

Question 55

Issues in Performance Evaluation *Mutual fund returns are calculated ________ of fees, but returns on managed portfolios are typically stated __________ to fees.

Answer 55

net, prior

Question 56

Sharpe Ratio vs Sharpe Benchmark

Answer 56

**Sharpe Ratio**: • 🧮 Formula-Based • 🎯 Risk-Adjusted Return • 📈 Comparison Between Portfolios **Sharpe Benchmark**: • 📊 Statistical Evaluation • 🔍 Style Analysis & Consistency • 🧭 Benchmarking Against Indexes