Chuckrox

intuition for the first year is that the excess return generated by the manager in year 1 is now available to be compounded at the market rate in year 2.

excess return generated in year 2.... hmm, intuition is less clear here. You've got the excess return earned in year 2 and you are compounding it by your full portfolio return last year.... I'm stumped on the logic, so I'll have to think on it more, but it does work out.