Reading 48: Global Performance Evaluation Los c~Q4-9

investment, management, research, directly, possible

Q4. Waterfront Capital Advisors (WCA) is the advisor to the Waterfront Funds, a family of nine no-load mutual funds with various investment objectives based in the United States. Rather than manage the mutual funds directly, WCA hires sub-advisors that assume the day-to-day management of each fund. Waterfront’s role is to research and find the best possible money manager to run each mutual fund and monitor each of the chosen managers to make sure they are meeting their investment objective.

Recently, WCA has become concerned about the Waterfront International Fund, a fund that focuses on developed international markets. The fund has underperformed its benchmark over the last 1 and 3 year periods, and is also underperforming the index year-to-date. The managers of the Fund, Blair Beshlian and Ed Haggerty believe the underperformance is related to construction of their benchmark. Beshlian states that although the benchmark has excellent coverage of the international market, the wide breadth of the benchmark has decreased the benchmark’s investability. Haggerty adds that countries which were formally classified as emerging market countries are seen as less important now that they have been added to their developed market index over the last year, which has decreased the investability of those countries.

In the second quarter of 2005, the Waterfront International Fund invested in three developed international markets: Japan (yen), the United Kingdom (Pound sterling), and France (Euro). During the second quarter of 2005, the yen, pound, and Euro depreciated against the U.S. dollar by 5%, 4%, and 2% respectively. The analyst team at WCA compiled the following additional information about the fund and its benchmark:

	Weight		Local Currency Return		U.S. Dollar Return
Country	Portfolio	Benchmark	Portfolio	Benchmark	Portfolio	Benchmark
Japan	40%	20%	21.00%	19.50%	14.95%	13.53%
United Kingdom	30%	40%	12.00%	13.50%	7.52%	8.96%
France	30%	40%	8.25%	10.00%	6.09%	7.80%

Waterfront is also concerned about the Waterfront Bond Fund, which is subadvised by Hiatt Associates. Waterfront hired Hiatt as an active bond manager, but Waterfront is concerned that Hiatt is being a “closet indexer” as the portfolio is tracking its capitalization-weighted fixed income benchmark almost exactly.

Regarding their reasons for underperformance being related to the construction of their benchmark:

A) Beshlian’s statement is valid; Haggerty’s statement is invalid

B) Beshlian’s statement is invalid; Haggerty’s statement is invalid.

C) Beshlian’s statement is valid; Haggerty’s statement is valid.

Q5. The currency allocation effect for the Waterfront International Fund was closest to:

A) 0.47%.

B) -0.28%.

C) -0.53%.

Q6. The market allocation effect for the Waterfront International Fund was closest to:

A) 1.23%.

B) 1.55%.

C) -1.92%.

Q7. The security selection effect for the Waterfront International Fund was closest to:

A) -0.38%.

B) 0.60%.

C) 0.47%.

Q8. The total effect for the Waterfront International Fund was closest to:

A) 0.93%.

B) ?0.71%.

C) 0.64%.

Q9. Traditionally, Waterfront Capital Management has used holdings-based analysis to analyze the managers of its funds, however, Joseph King, WCA’s Director of Research believes that returns-based style analysis is a superior methodology. King cites the following reasons to support his claim:

Reason 1:	One of the problems with portfolio-based style analysis is the both the fund composition and the benchmark composition need to be known, but this information can be difficult to obtain.

Reason 2:	Since returns-based style analysis classifies funds based on actual fund performance in relation to index returns representing specific asset classes, the fund manager will always know exactly what asset classes are in the fund.

Reason 3:	Data input requirements means that returns-based style analysis is quick to detect any changes in a manager’s style.