PORTFOLIO PERFORMANCE EVALUATION

Question 1

Describe the three interrelated components of performance evaluation

Answer 1

Performance measurement : What performance did the fund achieve during the period?

Performance attribution : How did the manager achieve this performance ?

Performance appraisal : Was this performance based on skill or luck ?

Question 2

Contrast micro-attribution vs macro-attribution

Answer 2

Micro-attribution analyzes the portfolio at the portfolio’s manager’s level and seek to verify if the portfolio did what they said they would.

Macro-attribution analyzes the portfolio at the fund sponsors level.

Question 3

Describe the three main approaches to conduct performance attribution

Answer 3

• Returns-based : Regress the portfolio returns based on major risk factors (size, value, market) to identify the active bets that the manager did.
• Holdings based : Use beginning of period holdings to assess the active sectors/stock selection bets of the manager and their contribution to active return. Drawback, it doesn’t take into consideration the change in position during the period.

Transaction based : Improvement of the holding based approach by including the impact of any trades executed during the period.

Question 4

In the Brinson-Hood-Beebower (BHB) Method, what are the three components of of active returns and how we calculate them.

Answer 4

Allocation effect : Active weights * Benchmark segment Return

Selection Effect : Active return * Benchmark weight

Interaction effect : Active weight * Active return

Question 5

In the Brinson-Fachler (BF) Method, what are the three components of of active returns and how we calculate them.

Answer 5

Allocation effect : Active weights * (Benchmark segment return - total Benchmark Return)

Selection Effect : Active return * Benchmark weight

Interaction effect : Active weight * Active return

Question 6

In equity attribution, describe one type of factor-based return attribution

Answer 6

Carhart model : Calculate the excess return from active portfolio management investment decisions by determining the impact on the portfolio due to factors like :

• Market index : Return on value weighted index compare to one month T-Bill rate
• Market Cap : Small vs big company, difference between the returns of 3 small cap company vs 3 big cap company
• Book to value price : High minus low : Difference between the average return of two high book to market portfolio vs two low book to market
• Momentum : winners minus losers - Difference between the returns on a portfolio of the past years winners and the return on a portfolio past years losers

Question 7

Describe what are the three common methods of fixed income attribution

Answer 7

Exposure Decomposition - Duration based : Duration, curve shape, sector selection and bond selection

Yield curve decomposition - Duration based : Yield or income, roll, shift, shape, spread and residual

Yield curve decomposition - full-repricing based : Breaks down the active return of the manager using individual spot rates for cash flows occuring at different maturities. Most precise approach but most complex.

Question 8

Define the primary types of benchmark

Answer 8

1. Absolute Benchmark
2. Broad market indexes
3. Style indexes
4. Factor-model based
5. Returns-based
6. Manager universe
7. Custom security-based

Question 9

Identify the different characteristics that a benchmark has to have to be consider a valid benchmark.

Answer 9

SAMURAI

1. Specified in advance
2. Appropriate
3. Measurable
4. Unambiguous
5. Reflective of the managers investment views
6. Accountable
7. Investable

Question 10

Describe how a portfolio’s return can be broken down

Answer 10

Can be broken down by :

• Market returns : Returns on the market index
• Style Returns : Benchmark return - market returns
• Active management : Portfolio return - Benchmark return

Question 11

Describe the three general type of benchmark that could be consider for hedge funds and why does it reflect some problems

Answer 11

Broad market index : Not appropriate since hedge funds cover a wide range of investment strategies. Low correlation with broad market indexes

Risk free rate + spread : Could be good for arbitrage strategies. Unfortunately, the vast majority of hedge funds will carry some systematic risk, and the use of leverage will only exacerbate the risk.

Hedge fund peer : Not suitable because a specific peer group’s risk and return objectives are not likely to match those of a specific hedge fund.

Question 12

How do we calculate the Sharpe Ratio

Answer 12

Rp - RF / standard deviation assets

Question 13

How do we calculate the Treynor Ratio

Answer 13

Rp - Rf / Beta portfolio

Question 14

How do we calculate the information Ratio

Answer 14

Active return/Active risk

Question 15

How do we calculate the Appraisal Ratio

Answer 15

Ratio of active return/ volatility of the residual term

Both derive from a factor based regression

To get the volatility of the error term, we can derive it from the CAPM model.

Variance of portfolio = Portfolio beta*variance of market + variance of error term from portoflio

Question 16

How do we calculate the Sortino Ratio

Answer 16

Portfolio return - Target acceptable rate / expected standard semideviation

Semideviation estimate the risk of bad volatility.

Question 17

How do we calculate the capture Ratio

Answer 17

Upside capture ratio : portfolio returns / benchmark returns – > if more than one, portfolio is outperforming the benchmark in positive market condition.

Downside capture : portfolio returns / benchmark returns – > If more than one, portfolio is underperforming the benchmark in downside market.

Capture ratio : Upside capture / downside capture

If capture ratio is greater than one, we have a positive asymmetrical return (convex). If capture ratio is lower than one, we have a negative asymmetrical (concave) profile and the portfolio underperform more in a downside market.

Question 18

What does drawdown determine in a portfolio

Answer 18

Drawdown is a measure, based on past performance, that calculates the maximum loss incurred if an investor had invested at a peak valuation and subsequently liquidated at a trough valuation. Drawdown duration is the total time required to fully recover a drawdown;