CFA CFA level 3 CFA level 3 CFA level 3 CFA level 3 CFA level 3 CFA level 3 finquiz item set questions, study session 7, reading 20

Reading 20

Market Indexes and Benchmarks

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CFA Level III Item-set - Question
Study Session 9
June 2018

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Reading 20

Market Indexes and Benchmarks

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FinQuiz Item-set ID: 21875
Questions 1(21876) through 6( 21881) relate to Reading 20

Greendale Associates Case Scenario
Greendale Associates is an asset management firm offering its clients three funds, Alpha, Beta,
and Gamma.
The Alpha Fund is a hedge fund executing a long-only equity strategy managed by Lance
Malkovich. His performance is compared to the top performing manager in the assigned manager
universe benchmark.
The Beta Fund has an active management mandate seeking exposure to the stocks of companies
with strong sustainability profiles and avoiding stocks of companies with negative social or
environmental impact. All companies operate in the emerging market. The performance of
Walsh Ruben, the fund’s equity manager, is being benchmarked to the MSCI Emerging Market
Social Responsibility Investment (SRI) index.
The index is reconstituted annually and its contents are defined by existing constituents. Only the
top-performing, most liquid SRI company stocks qualify for inclusion. The index limits
excessive concentration in any company by concentrating maximum corporate exposure to 5%.
The index is float-adjusted and cap-weighted.
The Gamma Fund invests in an exchange-traded fund which tracks the S&P 500. The fund is
managed by Rachel Cummings. Cummings is subject to a maximum 10% investment restriction
in any index stock.
The current year’s performance of all three managers relative to their respective benchmark is
summarized in the Exhibit.
Exhibit:
Performance of Fund Managers Relative to Respective Benchmarks
Annual Fund Return
Annual Benchmark
Manager
(%)
Return (%)
Malkovich
22

20
Ruben
16
18
Cummings
12
12

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Reading 20

Market Indexes and Benchmarks

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During an informal meeting between Cummings and Ruben, the managers discuss the
shortcomings of index weighting schemes:
Statement 1: “The weighting scheme of cap-weighted indexes is not without flaws. As a stock’s
market-cap falls, the index will own less of the company; this will decrease the
company’s representation in the index.”
Statement 2: “With a fixed security count, indexers tracking the S&P 500 should experience
lower turnover and a reduced need for rebalancing in comparison to an index with
a broad equity exposure.”

FinQuiz Question ID: 21876

1.   Using the information in the Exhibit and on the designated manager universe benchmark,
determine which manager should be awarded a bonus for his or her performance relative to
the benchmark?
A.   Malkovich
B.   Ruben
C.   Cummings
FinQuiz Question ID: 21877

2.   A limitation of using the MSCI Emerging market index as benchmark for the Beta Fund is
that it may serve as a poor:
A.   asset allocation proxy.
B.   basis for investment vehicles.
C.   investment manager mandate.
FinQuiz Question ID: 21878

3.   Which of the following index construction trade-offs most likely poses a limitation when
using a MSCI Global SRI Index?
A.   Completeness vs. investibility
B.   Rebalancing and reconstitution vs. turnover
C.   Objective and transparent rules vs. subjective judgment
FinQuiz Question ID: 21879

4.   If Cummings investment objective is to obtain small-cap equity exposure, a limitation of
using the S&P 500 as performance benchmark least likely excludes:
A.   she may not be able to track the index.
B.   the index will require frequent rebalancing.
C.   a property of a valid benchmark will be violated.

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Reading 20

Market Indexes and Benchmarks

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FinQuiz Question ID: 21880

5.   Statement 1 is most likely:
A.   correct.
B.   incorrect; changes in market-cap do not influence a company’s representation.
C.   incorrect; this ensures that tracking portfolios will be efficient from a risk-return
perspective.
FinQuiz Question ID: 21881

6.   Statement 2 is most likely:
A.   correct.
B.   incorrect; the index will need to be rebalanced frequently.
C.   incorrect; an index with a fixed number of securities will have higher turnover.

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