Reading 43: Evaluating Portfol....rmance－LOS s involved, including, investment

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 16: Performance Evaluation and Attribution
Reading 43: Evaluating Portfolio Performance
LOS s: Discuss the issues involved in manager continuation policy decisions, including the costs of hiring and firing investment managers.

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Suppose that a portfolio management firm has abnormally high turnover in their staff. Which of the following is the most likely scenario?

A) The firms Type I error rate is high and their Type II error rate is high.

B) The firms Type I error rate is low and their Type II error rate is low.

C) The firms Type I error rate is low and their Type II error rate is high.

D) The firms Type I error rate is high and their Type II error rate is low.

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Answer and Explanation

Type I error is retaining a poor manager and Type II error is firing a superior manager. If a firm has high turnover in staff, it is unlikely they are retaining poor managers but more likely that they are firing good managers.

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Suppose that a portfolio management firm has decided that the costs of hiring and firing managers are excessive. Which of the following would be their most appropriate course of action? The firm should:

A) tolerate more Type I error to reduce Type II error.

B) tolerate more Type II error to reduce Type I error.

C) reduce both Type I and Type II errors.

D) tolerate more Type I and Type II errors.

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Answer and Explanation

Type I error is retaining a poor manager and Type II error is firing a superior manager. If a firm wishes to reduce the costs of hiring and firing managers, then they should reduce staff turnover. So they should err on the side of retaining poor managers (Type I error) to reduce the chance of firing superior managers (Type II error). They might do this by relaxing the performance criteria managers must meet.

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Which of the following would NOT be a feature of a well formulated manager continuation policy?

A) A formalized, written manager continuation policy including goals and guidelines.

B) Underperformance, in any circumstances, will lead to automatic replacement of the manager.

C) Regular periodic manager review should be undertaken.

D) Decisions to replace managers should always be taken on a clear cost benefit analysis basis.

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Answer and Explanation

Short periods of underperformance should not necessarily lead to automatic replacement of the manager. Underperformance for consecutive review periods should put the plan sponsor on notice of a potential problem.