Misfit Risk/Core Satellite/Completeness Fund Question generated, following, investor, correct, manager

king_kong

In which of the following portfolios would misfit risk be largest? A portfolio:

A) generated using a core-satellite approach.
B) generated using a completeness fund approach.
C) that is indexed to a broad market.
Your answer: C was incorrect. The correct answer was A) generated using a core-satellite approach.

Whenever the manager’s portfolio diverges significantly from the investor’s portfolio, there will be misfit risk. An investor’s portfolio is one that the investor uses to evaluate the manager and may not be appropriate for their style. The investor’s portfolio is usually a broad market benchmark for that asset class. By design, the completeness fund results in a reduction of misfit risk. The indexed portfolio will have small misfit risk. The portfolio generated using a core-satellite approach will have the highest misfit risk because the satellite portfolios allow for specialized manager styles.


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Just not getting this one. Is there a simpler way to explain this? I picked C because I thought indexing to a broad market does not reflect managers style and thus is the cause of misfit return. They seem to say this in the answer but then say "The indexed portfolio will have small misfit risk". Essentially, I get why B is wrong but don't get why C is wrong and why A is right. Thanks.

wake2000

the purpose of a completeness fund is to "eliminate" misfit risk

thommo77

A seems like the best choice here. C is automatically out because you are essentially an indexer. B is also out because you are taking a concentrated position and diversifying it to act more like an index.

NO EXCUSES