FinQuiz smart summary, study session 17, reading 42

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2013, Study Session # 17, Reading # 42

“GLOBAL PERFORMANCE EVALUATION”
GPE = Global Performance Evaluation

SD = Standard Deviation

1. PERFORMANCE ATTRIBUTION IN GLOBAL PERFORMANCE EVALUATION

A portfolio is broken down into various segments according to type of asset &
currency to conduct GPE.
Return in local currency: ‫ݎ‬௝ = ܲ௝ + ݀௝
where
ܲ௝ = capital gains in %
݀௝ = yield in %
Return in base currency:
‫ݎ‬௝௢ = ܲ௝ + ݀௝ + ‫ܥ‬௝
where
‫ܥ‬௝ = currency component.
Total-return decomposition:
‫∑ = ݎ‬௝ ܹ௝ ܲ௝ + ∑௝ ܹ௝ ݀௝ + ∑௝ ܹ௝ ‫ܥ‬௝

it is simply the weighted average of the return on all segments.

Performance Attribution

Comparing all major investment decisions with
some passive benchmark.

Security Selection

ܴ௝௢ = ‫ܫ‬௝ + ൫ܲ௝ − ‫ܫ‬௝ ൯ + ݀௝ + ‫ܥ‬௝
Where
‫ܫ‬௝ = return in local currency for segment j

൫ܲ௝ − ‫ܫ‬௝ ൯ = security selection return (assuming the portfolio has
market level risk).
The 1st term measures the performance as the manager invested
passively in a local market index.
Assumption ⇒ price only indexes.

Comparisons with a Global Benchmark

Performance of the total portfolio relative to that of global benchmark.
Portfolio return:
‫ܹ ∑ = ݎ‬௝∗‫ܫ‬௝଴ + ∑൫ܹ௝ − ܹ௝∗ ൯‫ܫ‬௝ + ∑൫ܹ௝ ‫ܥ‬௝ − ܹ ∗ ‫ܥ‬௝ ൯ + ∑ ܹ௝ ݀௝ + ∑ ‫ݓ‬௝ ൫ܲ௝ − ‫ܫ‬௝ ൯
where
1st term = international benchmark return in base currency.
2nd term = market allocation contribution.
3rd term = currency allocation contribution.
4th term = yield component.
Last term = security selection contribution.
Manager’s performance can be attributed to:
A market allocation different from that of the index.
A currency allocation different from that of the index.
Security selection.
Risk budgeting ⇒ counterpart of performance attribution in the return dimension.

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2013, Study Session # 17, Reading # 42

Currency Management

Passive currency management ⇒ matching the currency weights in the
benchmark.
Currency exposure may be managed by currency overlay manager.
Two ways to analyze active currency exposure:
Country weights different from those in the benchmark.
Active currency bets by the manager.
Derivatives can be used to engage in currency hedging with forward/future
currency contracts.

Multi-period Attribution Analysis

Single Attribute

Multiple Attributes

Difference b/w the portfolio & benchmark return can be
attributed to security selections(S).
For two successive periods:

For each short period, calculate the performance of the
portfolio relative to benchmark & decompose it additively.
Two period contribution processes is similar as single attribute.

Method can generalize over a large number of periods.

ܴଵ − ܴଵ = ܵଵ
ܴଶ − ܴଶ = ܵଶ
where
R = portfolio return
ܴ = benchmark return
These are not simple sum but are linked return.
The correct two period attribute is not equal to either simple
sum or compounded return.

2.PERFORMANCE APPRAISALS IN GLOBAL PERFORMANCE EVALUATION

Risk

Total or Absolute Risk

Relative Risk

Measured by SD over time.
Usually annualized & expressed in % per year.

Active risk ⇒ deviation from passive benchmark.
Usually annualized & expressed in % per year.

Risk-Adjusted Performance

Sharpe Ratio

Information Ratio

Should only be used for the total global portfolio as it
focuses on the total risk of portfolio.

ா௫௖௘௦௦௥௘௧௨௥௡
்௥௔௖௞௜௡௚௘௥௥௢௥

Measures whether the alpha is large relative to
tracking error incurred.

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2013, Study Session # 17, Reading # 42

Risk Allocation & Budgeting

Risk allocation ⇒ Decomposing total risk into various
risk exposures taken.
Risk budgeting ⇒ process of allocating active risk
among managers.

Potential Biases in Risk & Return

Past risk & return figures can be biased estimate of the future because of:
Infrequently traded assets.
Option-like investment strategies.
Survivorship biased risk & return.

3. IMPLEMENTATION OF PERFORMANCE EVALUATION

Traditional approach to evaluate performance ⇒ compares the return on a
managed fund with that of peers.
Performance of an asset manager should be judged relative to customized
benchmarks.
Important issues in constructing customized benchmarks:
Individual country weight.
Countries, industries & style.
Currency hedging.

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