Reading 49: Global Investment ....mance Standards－LOS e class, including, standards, Investment

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 18: Global Investment Performance Standards
Reading 49: Global Investment Performance Standards
LOS e: Summarize and justify the requirements of the GIPS standards with respect to return calculation methodologies, including the treatment of large external cash flows, cash and cash equivalents, and fees and expenses.

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Achieving comparability among investment management firms performance presentations requires uniformity in methods used to calculate returns. Which of the following statements concerning Global Investment Performance Standards (GIPS) calculation methodology is FALSE?

A) If a firm sets a minimum asset level for portfolios to be included in a composite, no portfolios below that asset level can be included in that composite.

B) Performance must be calculated prior to the deduction of all trading expenses.

C) In both the numerator and the denominator, the market values of fixed-income securities must include accrued income.

D) Total return, including realized and unrealized gains plus income, must be used.

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Answer and Explanation

Performance must be calculated after the deduction of all trading expenses. (GIPS Standard 2.A.5)

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The Alexo Investment Management Group manages the investments for 30 retail clients. Alexo has full discretion over the investments of these clients assets. At the close of each day, the excess cash in the clients portfolios is swept into a money market fund. Alexo does not manage the money market fund, so it does not include the cash portion of the portfolio in its total return performance calculations. Alexo discloses its treatment of cash and cash equivalents in its performance presentation.

Which of the following statements is TRUE regarding Alexos compliance with the Global Investment Performance Standards (GIPS)? Alexo is:

A) not in compliance with the GIPS standards. The Standards require cash to be included in total returns calculations if the portfolio manager has control over the amount of the portfolio that is allocated to cash.

B) in compliance with the GIPS standards. The Standards do not require excess cash to be included in total return performance calculations unless the composite consists primarily of cash or cash equivalents.

C) in compliance with the GIPS standards. The Standards do not require firms to include cash in total returns calculations as long as the amount of cash or cash equivalents that is excluded is disclosed.

D) in compliance with the GIPS standards. The Standards do not require cash or cash equivalents to be included in total return performance calculations unless the portfolio manager has control over the management of the cash or cash equivalents.

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Answer and Explanation

GIPS Standard 2.A.4 requires the returns from cash and cash equivalents held in portfolios to be included in total-return calculations as long as the portfolio manager has control over the amount of the portfolio that is allocated to cash. This requirement stands even if the manager does not actually control the investment of the cash, as is the case when it is held in a money market sweep account.

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Consider the total quarterly returns for the growth and income composite of Zest Investment Management (ZIM): Q1 = 3.20%, Q2 = 4.25%, Q3 = 3.95%, Q4 = 3.35%. What is the appropriate total annual return under the calculation methodology under the Global Investment Performance Standards (GIPS)?

A) 14.48%.

B) 12.41%.

C) 15.58%.

D) 14.75%.

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Answer and Explanation

GIPS Standard 2.A.2 requires periodic returns to be geometrically linked. Thus, the annual return is computed as:

R_Annual = [(1 + R_Q1) × (1 + R_Q2) × (1 + R_Q3) × (1 + R_Q4)] 1

= (1.032)(1.0425)(1.0395)(1.0335) 1 = 15.58%

R_Annual = [(1 + R_Q1) × (1 + R_Q2) × (1 + R_Q3) × (1 + R_Q4)] 1

= (1.032)(1.0425)(1.0395)(1.0335) 1 = 15.58%

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Judy Picoo, CFA, a portfolio manager for the JP Fund, needed to compute her portfolio performance results for the 2003 first calendar quarter in compliance to GIPS. The following monthly results and information were available:

January 2003: +2.3%

February 2003: 1.0%

March 2003: The market value of her portfolio was $50 million on February 28, 2003, and $51.5 million on March 31, 2003. The portfolio did experience a redemption of $500,000 on March 15, 2003

Calculate the return for the month of March 2003 using the modified Dietz method.

A) 3.02%.

B) 2.01%.

C) 4.02%.

D) 1.25%.

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Answer and Explanation

GIPS permitted time-weighted rates of return until January 1, 2005, at which time, GIPS required time-weighted rates of return adjusted for daily-weighted cash flows (modified Dietz method). In order to compute the monthly return for the month of March 2003, use the following formula for the modified Dietz method:

R = [51,500,000 - 50,000,000 - (-500,000)] / [50,000,000 + (-500,000 x 0.51613)] = 4.02%

W = (31 - 15)/31 = 0.51613

R = [51,500,000 - 50,000,000 - (-500,000)] / [50,000,000 + (-500,000 x 0.51613)] = 4.02%

W = (31 - 15)/31 = 0.51613

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Calculate the quarterly return for the first quarter of 2003.

A) 5.35%.

B) 1.10%.

C) 4.47%.

D) 2.19%.

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Answer and Explanation

GIPS require that periodic returns must be geometrically linked. The following formula shall apply:

R_Q = [(1 + R₁) × (1 + R₂) × (1+R₃)] 1

where:

R_Q = quarterly return

R₁ = return for month 1

R₂ = return for month 2

R₃ = return for month 3

R_Q = [(1 + 0.023) × (1 + (-0.01)) × (1 + 0.0402)] - 1 = 5.35% for the first quarter of 2003

GIPS require that periodic returns must be geometrically linked. The following formula shall apply:

R_Q = [(1 + R₁) × (1 + R₂) × (1+R₃)] 1

where:

R_Q = quarterly return

R₁ = return for month 1

R₂ = return for month 2

R₃ = return for month 3

R_Q = [(1 + 0.023) × (1 + (-0.01)) × (1 + 0.0402)] - 1 = 5.35% for the first quarter of 2003