LOS u: Review the process of identifying, selecting, and contracting with equity managers, including the development of a universe of suitable candidates based on both qualitative and quantitative factors, the composition of equity manager questionnaires, and the analysis of fee structures.
Q1. If an investor is concerned that his or her equity manager might undertake too much risk, which of the following provisions in the equity manager’s compensation plan should be included?
A) Stock options.
B) A fee cap.
C) A high water mark provision.
Q2. Which of the following equity manager compensation plans would create the greatest incentive for performance?
A) A symmetric compensation plan.
B) A base compensation plus bonus and stock options.
C) A base compensation plus stock options.
Q3. Which of the following provisions in an equity manager’s compensation plan would create symmetry in the compensation?
A) A high water mark provision.
B) A fee cap.
C) Stock options.
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Q1. If an investor is concerned that his or her equity manager might undertake too much risk, which of the following provisions in the equity manager’s compensation plan should be included?
A) Stock options.
B) A fee cap.
C) A high water mark provision.
Correct answer is B)
A performance-based fee may include a fee cap where a maximum is placed on the performance fee. The intent is to prevent managers from undertaking too much risk to earn higher fees.
Q2. Which of the following equity manager compensation plans would create the greatest incentive for performance?
A) A symmetric compensation plan.
B) A base compensation plus bonus and stock options.
C) A base compensation plus stock options.
Correct answer is A)
Performance-based fees align the interests of the equity manager and the investor, especially if they are symmetric. A symmetric compensation plan has both rewards for good performance and punishment for bad performance. Both remaining responses do not punish the manager for bad performance.
Q3. Which of the following provisions in an equity manager’s compensation plan would create symmetry in the compensation?
A) A high water mark provision.
B) A fee cap.
C) Stock options.
Correct answer is A)
Symmetry refers to when the manager receives both rewards for good performance and punishment for bad performance. A high water mark provision states that a manager must compensate for past underperformance before receiving a performance-based fee. This is the only compensation provision mentioned in the responses that punishes for bad performance so it is the only one that provides symmetry.
Thx!
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