Reading 43: Evaluating Portfolio Performance－LOS h manager

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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 h: Judge the validity of using manager universes as benchmarks.

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Fund Sponsors often use the median account in a particular universe of account returns as an appropriate benchmark. This form of benchmark has a number of drawbacks. Which of the following is NOT a drawback that would be associated with using the median account as a benchmark?

A) It is virtually impossible to identify the median manager in advance.

B) As the median manager is unknown, the measure is ambiguous.

C) The benchmark is not investable as the median account will differ from one period to another.

D) It is not measurable as its value cannot be determined on a reasonably frequent basis.

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Answer and Explanation

There are seven properties of a valid benchmark. With regards to the median account approach, its value is measurable. This is probably the only criteria that the median manager approach satisfies. All the other statements are true of the median account.

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Which of the following best characterizes manager universes as a benchmark? Manager universes:

A) are not a valid benchmark because they are not investable.

B) are not a valid benchmark because they are not measurable.

C) are a valid benchmark because they are measurable.

D) retain the performance records of poor managers.

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Answer and Explanation

Manager universes are not a valid benchmark because they are not investable, are not specified in advance, and are not unambiguous. It is also impossible to determine if they are appropriate due to the ambiguity of the median manager. Furthermore, the performance records of poor managers are dropped from manager universes so there is an upward bias (i.e., survivorship bias) where the median managers return is inflated. The only property of a valid benchmark that manager universes fulfill is that they are measurable.

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Which of the following best describes the impact of survivorship bias on using manager universes as benchmarks?

A) Fund sponsors are reluctant to terminate underperforming funds, these accounts survive in the benchmark, and the median will be biased downwards.

B) Fund sponsors will terminate underperforming managers, underperforming accounts will not survive, and the median will be biased upwards.

C) A reluctance by fund sponsors to terminate underperforming funds will dampen any survivorship bias as the above average returns of surviving funds is reduced by the underperforming funds retained in the benchmark.

D) As consistently underperforming funds are terminated by the fund sponsors, the surviving funds shrink in number such that in a fairly short period of time the number of funds is too small to allow meaningful benchmarking.

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Answer and Explanation

The evidence is clear. Fund sponsors will rationally terminate underperforming managers, underperforming accounts will not survive, and the median will be biased upwards. Fund sponsors demonstrate little appetite for underperforming accounts and they are quickly removed.