CFA三级原版书课后题：交易、绩效评估与经理人选择-打印版

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TradeStrategyandExecution

Case:RobertHarding

¾RobertHardingisaportfoliomanageratValleyRise,ahedgefund

basedintheUnitedStates.Hardingmonitorstheportfolioalongside

AndreaYellow,ajunioranalyst.ValleyRiseonlyinvestsinequities,but

Hardingisconsideringotherassetclassestoaddtotheportfolio,

namelyderivatives,fixedincome,andcurrencies.HardingandYellow

meettodiscusstheirtradingstrategiesandpricebenchmarks.

¾HardingbeginsthemeetingbyaskingYellowaboutfactorsthataffect

theselectionofanappropriatetradingstrategy.YellowtellsHarding:

Statement1Tradingwithgreaterurgencyresultsinlowerexecution

risk.

Statement2Tradinglargersizeorderswithhighertradeurgency

reducesmarketimpact.

Statement3Securitieswithhighratesofalphadecayrequireless

aggressivetradingtorealizealpha.

¾AfterfurtherdiscussionaboutYellow’sstatements,Hardingprovides

Yellowalistoftradesthathewantstoexecute.HeasksYellowto

recommendapricebenchmark.Hardingwantstouseabenchmark

wherethereferencepriceforthebenchmarkiscomputedbasedon

marketpricesthatoccurduringthetradingperiod,excludingtrade

outliers.

Case:RobertHarding

¾Earlierthatdaybeforethemeeting,Yellowbelievedthatthemarket

hadunderreactedduringthepre-markettradingsessiontoastrong

earningsannouncementfromABCCorp.,acompanythatYellowand

Hardinghavebeenthoroughlyresearchingforseveralmonths.Their

researchsuggestedthestock’sfairvaluewas$90pershare,andthe

strongearningsannouncementreinforcedtheirbeliefintheirfairvalue

estimate.

Case:RobertHarding

¾Rightaftertheearningsannouncement,thepre-marketpriceofABC

was$75.Concernedthattheunderreactionwouldbeshort-lived,

HardingdirectedYellowtobuy30,000sharesofABCstock.Yellowand

Hardingdiscussedatradingstrategy,knowingthatABCsharesarevery

liquidandtheorderwouldrepresentonlyabout1%oftheexpected

dailyvolume.Theyagreedontradingaportionoftheorderatthe

openingauctionandthenfillingtheremainderoftheorderafterthe

openingauction.Thestrategyforfillingtheremainingportionofthe

orderwastoexecutetradesatpricesclosetothemarketpriceatthe

timetheorderwasreceived.

¾HardingandYellowthenshifttheirconversationtoXYZCorp.Harding

tellsYellowthat,afterextensiveresearch,hewouldliketoutilizean

algorithmtopurchasesomesharesthatarerelativelyliquid.When

buildingtheportfolio’spositioninXYZ,Harding’spriorityistominimize

thetrade’smarketimpacttoavoidconveyinginformationtomarket

participants.Additionally,Hardingdoesnotexpectadverseprice

movementsduringthetradehorizon.

Case:RobertHarding

¾HardingandYellowconcludetheirmeetingbycomparingtrade

implementationforequitieswiththetradeimplementationforthenew

fixed-income,exchange-tradedderivatives,andcurrencyinvestments

underconsideration.YellowtellsHarding:

Statement4Smallcurrencytradesandsmallexchange-traded

derivativestradesaretypicallyimplementedusingthedirectmarket

access(DMA)approach.

Statement5Thehigh-touchagencyapproachistypicallyusedto

executelarge,non-urgenttradesinfixed-incomeandexchange-traded

derivativesmarkets.

Case:RobertHarding

¾Thenextday,HardinginstructsYellowtorevisittheirresearchonBYYP,

Inc.Yellow’sresearchleadshertobelievethatitssharesare

undervalued.ShesharesherresearchwithHarding,andat10a.m.he

instructshertobuy120,000shareswhenthepriceis$40.00usinga

limitorderof$42.00.

¾Thebuy-sidetraderreleasestheorderformarketexecutionwhenthe

priceis$40.50.Theonlyfeeisacommissionof$0.02pershare.Bythe

endofthetradingday,90,000sharesoftheorderhadbeenpurchased,

andBYYPclosesat$42.50.Thetradewasexecutedatanaverageprice

of$41.42.DetailsabouttheexecutedtradesarepresentedinExhibit1.

Exhibit1BYYPTradeExecutionDetails

Case:RobertHarding

¾Whilethebuy-sidetraderexecutestheBYYPtrade,HardingandYellow

reviewValleyRise’stradepolicydocument.Afterreviewingthe

document,Yellowrecommendsseveralchanges:1)addapolicyforthe

treatmentoftradeerrors;2)addapolicythatensuresover-the-counter

derivativesaretradedonvenueswithrulesthatensureminimumprice

transparency;and3)alterthelistofeligiblebrokerstoincludeonly

thosethatprovideexecutionatthelowestpossibletradingcost.

Case:RobertHarding

¾WhichofYellow’sstatementsregardingthefactorsaffectingthe

selectionofatradingstrategyiscorrect?

Greatertradeurgencyresultsinlowerexecutionriskbecausetheorder

isexecutedoverashorterperiodoftime,whichdecreasesthetimethe

tradeisexposedtopricevolatilityandchangingmarketconditions.In

contrast,lowertradeurgencyresultsinhigherexecutionriskbecause

theorderisexecutedoveralongerperiodoftime,whichincreasesthe

timethetradeisexposedtopricevolatilityandchangingmarket

conditions.

Case:RobertHarding

¾GiventheparametersforthebenchmarkgivenbyHarding,Yellow

shouldrecommendabenchmarkthatisbasedonthe:

A.arrivalprice.

B.time-weightedaverageprice.

C.volume-weightedaverageprice.

Case:RobertHarding

¾Solution:B.

HardingaskedYellowtoexecutealistoftrades,andhewantstouseaprice

benchmarkwherethereferencepriceforthebenchmarkiscomputedbasedon

marketpricesthatoccurduringthetradingperiod,excludingtradeoutliers.

Portfoliomanagersoftenspecifyanintradaybenchmarkforfundsthatare

tradingpassivelyovertheday,seekingliquidity,andforfundsthatmaybe

rebalancing,executingabuy/selltradelist,andminimizingrisk.Anintraday

pricebenchmarkisbasedonapricethatoccursduringthetradingperiod.The

mostcommonintradaybenchmarksusedintradingarevolume-weighted

averageprice(VWAP)andtime-weightedaverageprice(TWAP).Portfolio

managerschooseTWAPwhentheywishtoexcludepotentialtradeoutliers.

B.aTWAPparticipationstrategy.

C.aVWAPparticipationstrategy.

Case:RobertHarding

¾Solution:A.

Giventhetradeurgencyoftheorder,theveryliquidmarketforABC

shares,andthesmallordersizerelativetoABC’sexpectedvolume,

Yellowisusinganarrivalpricetradingstrategythatwouldattemptto

executetheremainingsharesclosetomarketpricesatthetimethe

orderisreceived.

Case:RobertHarding

¾WhattypeofalgorithmshouldbeusedtopurchasetheXYZshares

givenHarding’spriorityinbuildingtheXYZpositionandhisbelief

aboutpotentialpricemovements?

A.Scheduledalgorithm

B.Arrivalpricealgorithm

C.Opportunisticalgorithm

¾Solution:A.

XYZsharesarerelativelyliquid,andHardinghasprioritizedminimizingthe

trade’smarketimpacttoavoidconveyinginformationtomarketparticipants.

Hardingalsodoesnotexpectadversepricemovementsduringthetrade

horizon.Scheduledalgorithmsareappropriateforordersinwhichportfolio

managersortradersdonothaveexpectationsforadversepricemovement

duringthetradehorizon.Thesealgorithmsarealsousedbyportfoliomanagers

andtraderswhohavegreaterrisktoleranceforlongerexecutiontimeperiods

andaremoreconcernedwithminimizingmarketimpact.Scheduledalgorithms

areoftenappropriatewhentheordersizeisrelativelysmall(e.g.,nomorethan

5%–10%ofexpectedvolume),thesecurityisrelativelyliquid,ortheordersare

partofarisk-balancedbasketandtradingallordersatasimilarpacewill

maintaintheriskbalance.

Case:RobertHarding

¾WhichofYellow’sstatementsregardingthetradeimplementationof

non-equityinvestmentsiscorrect?

A.OnlyStatement4

B.OnlyStatement5

C.BothStatement4andStatement5

Case:RobertHarding

¾Solution:A.

Smallcurrencytradesareusuallyimplementedusingdirectmarket

access(DMA).Buy-sidetradersgenerallyuseDMAforexchange-

tradedderivatives,particularlyforsmallertrades.

¾BasedonExhibit1,theexecutioncostforpurchasingthe90,000shares

Case:RobertHarding

¾Solution:C.

Executioncostiscalculatedasthedifferencebetweenthecostofthereal

portfolioandthepaperportfolio.Itreflectstheexecutionprice(s)paidforthe

numberofsharesintheorderthatwereactuallyfilledorexecuted.The

executioncostiscalculatedas:

š‡…—–‹‘…‘•–ൌ෍ܵܲെ෍ܵܲ

௝௝

௝ௗ

ൌሾሺͳͲǡͲͲͲ•Šƒ”‡•ൈ̈́ͶͲǤ͹ͷሻ൅ሺ͵ͲǡͲͲͲ•Šƒ”‡•ൈ̈́ͶͳǤʹͷሻ൅ሺʹͲǡͲͲͲ•Šƒ”‡•

ൈ̈́ͶͳǤͷͲሻ൅ሺ͵ͲǡͲͲͲ•Šƒ”‡•ൈ̈́ͶͳǤ͹ͷሻሿȂሺͻͲǡͲͲͲൈ̈́ͶͲǤͲͲሻ

ൌ̈́͵ǡ͹ʹ͹ǡͷͲͲȂ̈́͵ǡ͸ͲͲǡͲͲͲ

ൌ̈́ͳʹ͹ǡͷͲͲ

Case:RobertHarding

¾BasedonExhibit1,theopportunitycostforpurchasingthe90,000

sharesofBYYPis:

Opportunitycostisbasedonthenumberofsharesleftunexecutedin

theorderandreflectsthecostofnotbeingabletoexecuteallshares

atthedecisionprice.Theopportunitycostiscalculatedas:

௝

௡

Case:RobertHarding

¾Thearrivalcostforpurchasingthe90,000sharesofBYYPis:

Case:RobertHarding

¾Solution:B.

Thearrivalcostiscalculatedas:

””‹˜ƒŽ…‘•–ሺ„’ሻൌ‹†‡ൈ

ܲ଴

ሺ̈́ͶͳǤͶʹെ̈́ͶͲǤͷͲሻ

ൌ൅ͳൈ

̈́ͶͲǤͷͲ

ସ

ൈͳͲ„’ൌʹʹ͹Ǥʹ„’

¾Asitrelatestothetradepolicydocument,ValleyRiseshouldimplement

A.thelistofeligiblebrokers.

Case:RobertHarding

¾Solution:B.

Firmsshouldhaveapolicyinplaceforthetreatmentoftradeerrors.

Errorsfromtradingandanyresultinggains/lossesneedtobe

disclosedtoafirm’scompliancedepartmentanddocumentedina

tradeerrorlog.Thetradeerrorlogshouldincludeanyrelated

documentationandevidencethattradeerrorsareresolvedinaway

thatavoidsadverseimpacttotheclient.

Reading35

PortfolioPerformanceEvaluation

¾AlexandraJones,asenioradviseratFederalistInvestors(FI),meetswith

ErinBragg,ajunioranalyst.Braggjustcompletedamonthly

performanceevaluationforanFIfixed-incomemanager.Bragg’sreport

addressesthethreeprimarycomponentsofperformanceevaluation:

measurement,attribution,andappraisal.JonesasksBraggtodescribe

aneffectiveattributionprocess.Braggrespondsasfollows:

Response1:Performanceattributiondrawsconclusionsregardingthe

qualityofaportfoliomanager’sinvestmentdecisions.

Response2:Performanceattributionshouldhelpexplainhow

performancewasachievedbybreakingapartthereturnorriskinto

differentexplanatorycomponents.

Case:AlexandraJones

¾Braggnotesthatthefixed-incomeportfoliomanagerhasstrongviews

abouttheeffectsofmacroeconomicfactorsoncreditmarketsand

followsatop-downinvestmentprocess.

¾JonesreviewsthemonthlyperformanceattributionandasksBragg

whetheranyrisk-adjustedhistoricalperformanceindicatorsare

available.Braggproducesthefollowingdata:

Case:AlexandraJones

Exhibit110-YearTrailingRisk-AdjustedPerformance

Averageannualreturn

Minimumacceptablereturn(MAR)

Sharperatio

Sortinoratio

0.87

Upsidecapture

0.66

A.OnlyResponse1

B.OnlyResponse2

Case:AlexandraJones

¾Solution:B.

Performanceattributionhelpsexplainhowperformancewasachieved;

itbreaksapartthereturnorriskintodifferentexplanatorycomponents.

Effectiveperformanceattributionmustaccountforalloftheportfolio’s

returnorriskexposure,reflecttheinvestmentdecision-makingprocess,

quantifytheactivedecisionsoftheportfoliomanager,andprovidea

completeunderstandingoftheexcessreturn/riskoftheportfolio.

Case:AlexandraJones

¾Themostappropriateriskattributionapproachforthefixed-income

manageristo:

A.decomposehistoricalreturnsintoatop-downfactorframework.

B.evaluatethemarginalcontributiontototalriskforeachposition.

C.attributetrackingrisktorelativeallocationandselectiondecisions.

Theportfolioismanagedagainstabenchmark,whichindicatesa

relative-risktypeofriskattributionanalysis.Foratop-down

investmentapproach,theanalysisshouldattributetrackingriskto

allocationandselectiondecisionsrelativetothebenchmark.

Case:AlexandraJones

¾BasedonExhibit1,thetargetsemideviationfortheportfolioisclosest

to:

Case:AlexandraJones

¾Solution:B.

Thetargetsemi-standarddeviationortargetsemideviationisthe

denominatoroftheSortinoratio.ThenumeratoroftheSortinoratiois

theaverageportfolioreturnminusthetargetrateofreturn(minimum

acceptablereturn,orMAR).

ƒ”‰‡–•‡‹†‡˜‹ƒ–‹‘

SubstitutingthevaluesprovidedinExhibit3,thetargetsemideviation

isasfollows:

ͺǤʹͲΨെͷǤͲͲΨ

ƒ”‰‡–•‡‹†‡˜‹ƒ–‹‘ൌ

ൌ͵Ǥ͸͹ͺΨൌ͵Ǥ͸ͺΨ

ͲǤͺ͹

B.positiveasymmetryofreturns.

C.thattheportfoliogenerateshigherreturnsthanthebenchmark

duringallmarketconditions.

Case:AlexandraJones

¾Solution:B.

Theupside/downsidecapture,orsimplythecaptureratio(CR),isthe

upsidecaptureratiodividedbythedownsidecaptureratio.

(Upsidecapture)/(Downsidecapture)=0.66/0.50=1.32.

Acaptureratiogreaterthan1indicatespositiveasymmetryofreturns,

oraconvexreturnprofile.

Case:AlexandraJones

¾ThemaximumdrawdownanddrawdowndurationinExhibit1indicate

that:

A.theportfoliorecoveredquicklyfromitsmaximumloss.

B.overthe10-yearperiod,theaveragemaximumlosswas–24.00%.

Maximumdrawdownisthecumulativepeak-to-troughlossduringa

continuousperiod.Drawdowndurationisthetotaltimefromthestart

ofthedrawdownuntilthecumulativedrawdownrecoverstozero,

whichcanbesegmentedintothedrawdownphase(starttotrough)

andtherecoveryphase(troughtozerocumulativereturn).The

maximumdrawdownwas–24.00%,withadrawdownperiodoffour

months.Giventhe10-yeartimeframe,theportfoliorecoveredquickly

fromitsmaximumloss.

Case:StephanieTolmach

¾StephanieTolmachisaconsultanthiredtocreateaperformanceattribution

reportonthreefundsheldbyadefinedbenefitpensionplan(thePlan).

Fund1isadomesticequitystrategy,Fund2isaglobalequitystrategy,and

Fund3isadomesticfixed-incomestrategy.

¾Tolmachusesthreeapproachestoattributionanalysis:thereturn-based,

holdings-based,andtransaction-basedapproaches.ThePlan’sinvestment

committeeasksTolmachto(1)applytheattributionmethodthatusesonly

eachfund’stotalportfolioreturnsoverthelast12monthstoidentify

return-generatingcomponentsoftheinvestmentprocessand(2)include

theimpactofspecificactiveinvestmentdecisionsandtheattribution

effectsofallocationandsecurityselectioninthereport.

Case:StephanieTolmach

¾TolmachfirstevaluatestheperformanceofFund1byconstructinga

FactorSensitivity

ContributiontoActiveReturn

FactorPortfolioBenchmarkDifferenceFactorReturn

Absolute

(3)h(4)

5.06%

0.29%

2.02%

–0.41%

6.96%

–10.95%

–3.99%

*

(2)

A.FactorTiltReturn:

B.SecuritySelection:

C.ActiveReturn(A+B):

*RMRFisthereturnonavalue-weightedequityindexinexcessoftheone-monthT-billrate,SMBis

thesmallminusbigmarketcapitalizationfactor,HMListhehighminuslowfactor,andWMListhe

winnersminuslosersfactor.

¾TolmachturnsherattentiontoFund2,constructingaregion-based

microattributionanalysistoevaluatetheactivedecisionsofthe

portfoliomanager.TheresultsarepresentedinExhibit2.

Exhibit2Fund2Performance—AllocationbyRegion

PortfolioBenchmark

GreaterEurope

42.35%

23.16%

25.43%

Developed

Australasia

SouthAmerica

Total

Asia

and

29.86%

31.16%

11.33%

12.85%

20.38%

100.00%

18.82%

100.00%

20.00%

18.26%

35.26%

22.67%

Case:StephanieTolmach

¾Next,TolmachevaluatesFund3andtheappropriatenessofits

benchmark.Thebenchmarkisacap-weightedbondindexwithdaily

reportedperformance;theindexisrebalancedfrequently,makingit

difficulttoreplicate.Thebenchmarkhasameaningfulinvestmentin

foreignbonds,whereasFund3investsonlyindomesticbonds.

¾Inthefinalsectionofthereport,TolmachreviewstheentirePlan’s

characteristics,assetallocation,andbenchmark.Tolmachobservesthat

thePlan’sbenefitsarenolongerindexedtoinflationandthatthe

workforceis,onaverage,youngerthanitwaswhenthecurrentfund

allocationswereapproved.Tolmachrecommendsachangeinthe

Plan’sassetallocationpolicy.

Case:StephanieTolmach

¾OfthethreeattributionapproachesreferencedbyTolmach,the

methodrequestedbythecommittee:

A.istheleastaccurate.

B.usestheunderlyingholdingsoftheactualportfolio.

C.isthemostdifficultandtimeconsumingtoimplement.

Thecommitteedescribedareturn-basedattribution,whichistheleast

accurateofthethreeapproaches(thereturn-based,holdings-based,

transaction-basedapproaches).Return-basedattributionusesonlythe

totalportfolioreturnsoveraperiodtoidentifythecomponentsofthe

investmentprocessthathavegeneratedthereturns.

Case:StephanieTolmach

¾BasedonExhibit1andrelativetothebenchmark,themanagerofFund

1mostlikelyuseda:

A.growthtilt.

Case:StephanieTolmach

¾Solution:A.

Basedonthefactorsensitivitiesincolumn1(negativesensitivityof–

0.17toHML)andthedifferencesrelativetothebenchmarkshownin

column3,themanagerlikelyhadagrowthtilt.

¾BasedonExhibit1,whichofthefollowingfactorscontributedtheleast

Case:StephanieTolmach

¾Solution:B.

Withanabsolutereturnof0.29%andwith7.33%ofthecontribution

toreturn,SMBcontributedfarlessthanHML(2.02%and50.53%,

respectively)andRMRF(5.06%and126.80%,respectively).

Case:StephanieTolmach

¾BasedonExhibit1,themanagercouldhavedeliveredmorevalueto

theportfolioduringtheinvestmentperiodbyweightingmoretoward:

A.valuestocks.

B.small-capstocks.

C.momentumstocks.

Hadthemanagerweightedmoretowardmomentumstocksduring

theperiod,themomentumfactor(WML)returnof3.38%wouldhave

contributedpositivelytotheportfolio.

AisincorrectbecausetheHMLfactorreturnwas–9.60%;thus,

weightingmoretowardvaluestockswouldhavedetractedfrom

portfolioreturns.

BisincorrectbecausetheSMBfactorreturnwas–3.25%;thus,

weightingmoretowardsmall-capstockswouldhavedetractedfrom

portfolioreturns.

Case:StephanieTolmach

¾BasedonExhibit2,theallocationeffectforSouthAmericaisclosestto:

Case:StephanieTolmach

¾Solution:C.

TheallocationeffectforSouthAmericais0.20%.

ŽŽ‘…ƒ–‹‘ൌሺ™ȂሻሺȂሻ

௜

ூ

௜

¾BasedonExhibit2,thedecisiontooverweightorunderweightwhichof

thefollowingregionscontributedpositivelytoperformanceatthe

overallfundlevel?

A.NorthAmerica

C.DevelopedAsiaandAustralasia

Case:StephanieTolmach

¾Solution:C.

ThedecisiontounderweightdevelopedAsiaandAustralasiawasa

goodonebecausethebenchmarkforthisregionunderperformedthe

totalbenchmark(12.85%versus22.67%).Alternatively,thequestion

canbeansweredbycalculatingtheallocationeffectsforthethree

regions,asfollows:

Case:StephanieTolmach

ŽŽ‘…ƒ–‹‘ൌሺ™ȂሻሺȂሻ

௜

ூ

௜

‘”–Š‡”‹…ƒൌሺͳͲǤͺͶΨȂ͹Ǥ͸͹Ψሻሺͳ͸ǤͶ͹ΨȂʹʹǤ͸͹Ψሻ

ൌȂͲǤʹͲΨ

DevelopedAsiaandAustralasiaistheonlyregionofthethreethathad

apositiveallocationeffect.

¾BasedonExhibit2,theunderperformanceattheoverallfundlevelis

predominantlytheresultofpoorsecurityselectiondecisionsin:

A.SouthAmerica.

B.greaterEurope.

C.developedAsiaandAustralasia.

Case:StephanieTolmach

¾Solution:A.

Thetotal–441bpsofunderperformancefromsecurityselectionand

interactionattheoverallfundlevelispredominantlytheresultofpoor

SouthAmericansecurityselectiondecisions(–311bps=3.11%).

ReturnAttribution

(SegmentLevel)

NorthAmerica

GreaterEurope

DevelopedAsiaandAustralasia

SouthAmerica

Allocation

Total

Total

Case:StephanieTolmach

ŽŽ‘…ƒ–‹‘ൌሺ™ȂሻሺȂሻ

௜

ூ

௜

‘”–Š‡”‹…ƒൌሺͳͲǤͺͶΨȂ͹Ǥ͸͹Ψሻሺͳ͸ǤͶ͹ΨȂʹʹǤ͸͹Ψሻ

ൌȂͲǤʹͲΨ

”‡ƒ–‡”—”‘’‡ൌሺ͵ͺǤͻʹΨȂͶʹǤ͵ͷΨሻሺʹͷǤͶ͵ΨȂʹʹǤ͸͹Ψሻ

ൌȂͲǤͲͻΨ

‘—–Š‡”‹…ƒൌሺʹͲǤ͵ͺΨȂͳͺǤͺʹΨሻሺ͵ͷǤʹ͸ΨȂʹʹǤ͸͹Ψሻ

ൌͲǤʹͲΨ

Selection+Interaction=WiR–B+w–WR–B

i

i

i

i

i

i

NorthAmerica=7.67%(16.50%–16.47%)+(10.84%–7.67%)(16.50%–16.47%)

=0.00%

GreaterEurope=42.35%(23.16%–25.43%)+(38.92%–42.35%)(23.16%–

25.43%)

=–0.88%

DevelopedAsiaandAustralasia=31.16%(11.33%–12.85%)+(29.86%–

31.16%)(11.33%–12.85%)

=–0.45%

SouthAmerica=18.82%(20.00%–35.26%)+(20.38%–18.82%)(20.00%–

35.26%)

=–3.11%

Case:StephanieTolmach

¾ThebenchmarkforFund3haswhichofthefollowingcharacteristicsof

avalidbenchmark?

Case:StephanieTolmach

¾Solution:B.

Dailyreportedperformanceisavailableforthebenchmark;thus,itispossible

tomeasurethebenchmark’sreturnonareasonablyfrequentandtimelybasis.

Aisincorrectbecausethebenchmarkisacap-weightedbondindexthatis

rebalancedfrequently,makingitdifficulttoreplicate.Forabenchmarktobe

investable,itmustbepossibletoreplicateandholdthebenchmarktoearnits

return(atleastgrossofexpenses).Thesponsorshouldhavetheoptionof

movingassetsfromactivemanagementtoapassivebenchmark.Ifthe

benchmarkisnotinvestable,itisnotaviableinvestmentalternative.Bond

indexesareoftennotinvestableandarerebalancedfrequentlyovertime.

Cisincorrectbecausetheindexhasameaningfulinvestmentinforeignbonds,

whereasFund3investsonlyindomesticbonds,makingthebenchmark

inappropriate.Thebenchmarkmustbeconsistentwiththemanager’s

investmentstyleorareaofexpertise.

Case:StephanieTolmach

¾BasedonthefinalsectionofTolmach’sreport,thePlanshoulduse:

A.aliability-basedbenchmark.

B.anabsolutereturnbenchmark.

C.amanageruniversebenchmark.

Case:StephanieTolmach

¾Solution:A.

BasedonthePlan’stype(definedbenefit)anditscharacteristicsas

detailedinthefinalsectionofTolmach’sreport,aliability-based

benchmarkismostappropriate.Liability-basedbenchmarksareused

mostfrequentlywhenassetsarerequiredtopayaspecificfuture

liability,asinadefinedbenefitpensionplan.

InvestmentManagerSelection

Case:TreeFallersEndowment

¾TheTreeFallersEndowmentplanstoallocatepartofitsportfolioto

alternativeinvestmentfunds.TheendowmenthashiredKurtSummer,a

consultantatSummerBrothersConsultants,toidentifysuitable

alternativeinvestmentfundsforitsportfolio.

¾Summerhasidentifiedthreefundsforpotentialinvestmentandwill

presenttheperformanceoftheseinvestmentstotheendowment’s

boardofdirectorsattheirnextquarterlymeeting.

¾Summerisreviewingeachofthefund’sfeeschedulesandisconcerned

aboutthemanager’sincentivetotakeonexcessriskinanattemptto

generateahigherfee.Exhibit1presentsthefeeschedulesofthethree

funds.

Case:TreeFallersEndowment

Exhibit1FeeSchedules

Maximum

AnnualFee

Fund

ComputedFee

Sharing

Higherofeither(1)baseor(2)baseplus

sharingofpositiveperformance;sharingis1.00%

basedonreturnnetofthebasefee.

20%

na

2.50%

na

Higherofeither(1)baseor(2)baseplus

BlueWatersharingofpositiveperformance,uptoa

0.50%

Fund

maximumannualfeeof2.50%;sharingis

basedonactivereturn.

¾Exhibit2presentstheannualgrossreturnsforeachfundandits

respectivebenchmarkfortheperiodof2016–2018.Allfundshavean

inceptiondateof1January2016.Summerintendstoincludeinhis

reportanexplanationoftheimpactofthefeestructuresofthethree

fundsonreturns.

Case:TreeFallersEndowment

Exhibit2FundandBenchmarkReturns

Year

2016

2017

2018

Benchmark

Benchmark

Benchmark

Fund

Red

Grass

Fund

Blue

Water

Fund

Yellow

Wood

Fund

8.00

10.00

15.00

8.00

–2.00

–4.00

–5.00

–10.00

–1.50

–6.50

5.00

14.00

7.00

4.50

2.00

9.50

9.00

14.00

Case:TreeFallersEndowment

¾TheboardofdirectorsoftheTreeFallersEndowmentasksSummerto

recalculatethefeesoftheRedGrassFundassumingahigh-watermark

featurewherebyasharingpercentagecouldonlybechargedtothe

extentanylosseshadbeenrecouped.

¾BasedonExhibit1,whichfundhasasymmetricalfeestructure?

Case:TreeFallersEndowment

¾Solution:C.

Asymmetricalfeestructureisoneinwhichthefeesareaffectedby

bothpositiveandnegativeperformance.OfthethreefundsinExhibit

1,onlyYellowWoodhasasymmetricalstructure.YellowWood’sprofit

sharingcomponentwillbenegativeifitsreturnisnegativeand

positiveifitispositive.

Case:TreeFallersEndowment

¾BasedonthefeeschedulesinExhibit1,theportfoliomanagerofwhich

fundhasthegreatestincentivetoassumeadditionalrisktoearna

higherinvestmentmanagementfee?

A.RedGrass

RedGrass’sfeearrangementallowsforunlimitedperformance-based

feesontheupsideandnonegativeconsequencesonthedownside.

Case:TreeFallersEndowment

¾BasedonExhibit1andExhibit2,theYellowWoodFund’s2016

investmentmanagement