Reading 33 Evaluating Portfolio Performance FinQuiz.com FinQuiz.com CFA Level III Item-set - Question Study Session 17 June 2018 Copyright © 2010-2018 FinQuiz.com All rights reserved Copying, reproduction or redistribution of this material is strictly prohibited info@finquiz.com FinQuiz.com © 2018 - All rights reserved Reading 33 Evaluating Portfolio Performance FinQuiz.com FinQuiz Item-set ID: 8546 Questions 1(8547) through 6(8552) relate to Reading 33 Leslie Wilson Case Scenario Leslie Wilson maintains a website where he likes to post his articles His articles have featured various topic areas including organizational issues, finance and investment management Wilson is currently working on an article related to managerial performance appraisals and manager continuation policies He feels he has never touched this subject before and needs to give it greater emphasis He has only prepared the introduction of the article The remainder of his article is in draft form An excerpt of the article is provided below The Need for a Manager Continuation Policy (MCP) It takes many years for an investment manager to generate extraordinary performance If you break their track record up, you’ll notice that a good chunk of the superior returns is dispersed over several years What does this imply? The solution to this question may be quite dreadful If a manager’s past performance is used as a benchmark, the manager’s job may be in jeopardy If I link this dreadful course of action to the statement made in the first paragraph, I wouldn’t be wrong to conclude that there is a high likelihood of superior managers underperforming and subsequently being fired over a short time frame There are also other drawbacks associated with frequent manager firings, which I have listed below: 1) waste of a sponsor’s time and expense 2) although there is no need for portfolio liquidation, a fired manager’s portfolio needs to be converted when moving the portfolio to a manager who possesses a different investment style The problems associated with manager firings have stressed the need for a manager continuation policy The Purpose of a MCP There are several purposes of a MCP, which are discussed further in the article The MCP Process The MCP process consists of two components: 1) Manager Monitoring 2) Manager Review FinQuiz.com © 2018 - All rights reserved Reading 33 Evaluating Portfolio Performance FinQuiz.com These components are discussed below Manager Monitoring I II III IV The goal of this process is to identify any potential signs of danger in the manager’s organization It is a formal process that helps to provide data on the manager’s operations As part of the manager monitoring process, the sponsor receives certain information The results of this process are used to remove inferior managers (underperforming over a long period of time) and retain the superior managers (outperforming over a long period of time) Manager Review I II III IV V This process will follow manager monitoring If the monitoring process identifies warning signs, a manager review becomes essential The review process is quite different from the manager selection process In contrast to the monitoring process, the review process involves making decisions regarding retaining or firing managers The criteria for conducting this process are independent from the hiring process There are namely three criteria used when making the firing/retention decision FinQuiz Question ID: 8547 The drawbacks highlighted by Wilson, in his article are most likely: A correct B incorrect with respect to drawback C incorrect with respect to drawback FinQuiz Question ID: 8548 The purposes of a MCP, which Leslie refers to, least likely include: A to maximize managerial turnover B to give emphasis to non-performance data in the evaluation process C to develop consistent organizational policies and procedures FinQuiz Question ID: 8549 In the context of the Manager Monitoring section, which of the points listed is/are least likely correct? A I and II B I and IV C IV only FinQuiz.com © 2018 - All rights reserved Reading 33 Evaluating Portfolio Performance FinQuiz.com FinQuiz Question ID: 8550 The ‘certain information’ Leslie refers to within point III of the Manager Monitoring section least likely includes: A operational matters B a discussion of the manager’s investment strategies on a retrospective and prospective basis C a discussion of the manager’s investment strategies on a retrospective basis only FinQuiz Question ID: 8551 In the context of the Manager Review section, which of the points listed is/are most likely incorrect? A II only B III and IV only C II, III and IV FinQuiz Question ID: 8552 The ‘three criteria’ Leslie refers to within point V of the Manager Review section, least likely include: A a cost and benefit analysis B an analysis of the fundamental changes in the manager’s operations C an analysis of the manager’s skills FinQuiz.com © 2018 - All rights reserved Reading 33 Evaluating Portfolio Performance FinQuiz.com FinQuiz Item-set ID: 8177 Questions 7(8178) through 12(8183) relate to Reading 33 Cremitia Associates Case Scenario Doug Owen, CFA develops testing material for CFA Program candidates The material is published in print form and sold internationally He is currently developing questions for the Level III candidates pertaining to benchmarks – their types, qualities, benefits and drawbacks He has created a table, provided below, with some missing entries Candidates are responsible for answering questions pertaining to the table Benchmark Type a) Description Benefits This can be illustrated Conceptually simple through a minimum return objective, which a pension fund must meet to fund retirement liabilities b) Manager Universes The fund sponsor selects a median manager from the broad universe of available managers or funds Measurable c) Factor-ModelBased By capturing the systematic sources of returns, they help managers and sponsors better understand the manager’s investment style d) Managers will use Possesses all required research to select the properties of best investment benchmark opportunities and construct a benchmark by weighting those identified opportunities e) These indices hypothetically lead to Users will be able to comprehend these FinQuiz.com © 2018 - All rights reserved Drawbacks Does not possess the properties of a legitimate benchmark It can be ambiguous as it is possible to construct one or more benchmarks with the same exposure but earning different returns Constituent securities and sectors may Reading 33 Evaluating Portfolio Performance segmenting a portfolio indices with little into various styles to difficulty create a suitable match between the portfolio and the index f) Broad Market Indices Popular indices, such as the S&P 500 and Wilshire 5000, are used as benchmarks FinQuiz.com possess undesirably large allocations There is a possible conflict of the manager’s actual investment style and the style implied by the benchmark Unambiguous, specified in advance and investable FinQuiz Question ID: 8178 Benchmark type ‘A’ most likely is: A manager universes B broad market indices C an absolute benchmark FinQuiz Question ID: 8179 The drawbacks of using manager universes as a benchmark least likely include: A the median account may only be established on an ex ante basis B different accounts will represent the median account across evaluation periods C they are subject to survivorship bias FinQuiz Question ID: 8180 The most appropriate description for a Factor-Based Model is: A it establishes a relationship between portfolio and market index return B it relates the beta on a security or portfolio to the return on the market index C the return of security is expressed as a non linear function of the return on a broad market index FinQuiz.com © 2018 - All rights reserved Reading 33 Evaluating Portfolio Performance FinQuiz.com FinQuiz Question ID: 8181 10 The benchmark type and drawback most appropriate for ‘D’ is: A Returns-based benchmark A drawback of this benchmark is that it may hold certain securities and sectors which the manager may find unacceptable B Custom-security based benchmark A drawback of this benchmark is that a majority of these indices are unpublished resulting in a lack of transparency C Custom-security based benchmark A drawback of this benchmark is that it will be difficult for some investment managers to monitor and control the investment process due to a lack of benchmark transparency FinQuiz Question ID: 8182 11 Benchmark type ‘E’ most likely is: A a returns-based benchmark B factor-based benchmark C a style Index FinQuiz Question ID: 8183 12 A drawback of a broad market index most likely includes: A a conflict of styles between the manager and the benchmark B expensive to obtain C difficult to obtain FinQuiz.com © 2018 - All rights reserved ... skills FinQuiz. com © 2018 - All rights reserved Reading 33 Evaluating Portfolio Performance FinQuiz. com FinQuiz Item- set ID: 8177 Questions 7(8178) through 12(81 83) relate to Reading 33 Cremitia.. .Reading 33 Evaluating Portfolio Performance FinQuiz. com FinQuiz Item- set ID: 8546 Questions 1(8547) through 6(8552) relate to Reading 33 Leslie Wilson Case Scenario... function of the return on a broad market index FinQuiz. com © 2018 - All rights reserved Reading 33 Evaluating Portfolio Performance FinQuiz. com FinQuiz Question ID: 8181 10 The benchmark type