burning0spear

Which of the following statements with regard to tests of benchmark quality is CORRECT?

A) Tracking error is defined as the variance of the excess returns earned due to active management.

B) An active position is the difference between the weight of a security in the managed portfolio versus the benchmark.

C) An account’s exposure to systematic risk should be similar to those of the benchmark at all times.

---

Tracking error is defined by standard deviation not variance. Exposure to systematic risk does not need to be the same at all times rather it should average that of the benchmark. The correct statement is the one in relation to active positions.

burning0spear

Consider the following relationships:

A = P – B
S = B – M

where:
A = the management’s active management decisions
P = the investment manager’s portfolio return
B = the benchmark return
S = the manager’s investment style
M = the market index

In the context of systematic bias which of the following outcomes is most desirable?

A) A manager's active returns should be positively correlated with the manager’s investment style.

B) A manager’s active returns should be negatively correlated with the manager’s investment style.

C) A manager’s active returns should be uncorrelated with the manager’s investment style.

---

A manager’s active returns should be uncorrelated with the manager’s investment style.

burning0spear

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

A) are a valid benchmark because they are measurable.

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

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

---

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 manager’s return is inflated. The only property of a valid benchmark that manager universes fulfill is that they are measurable.

burning0spear

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

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

---

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

burning0spear

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

A) 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.

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

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

---

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.

burning0spear

Which of the following is least likely to be a step in the construction of a custom security-based benchmark?

A) Use the same assets for the benchmark as the manager.

B) Rebalance the portfolio on a periodic basis.

C) Minimize misfit risk for the benchmark.

---

Misfit risk results from differences between the manager’s normal portfolio and the broader asset class benchmark. In a custom security-based benchmark, there will be and should be misfit risk if the manager’s style is different than the broad market and if the custom benchmark accurately reflects the manager’s style.

burning0spear

Which of the following is least likely to be a step in the construction of a custom security-based benchmark?

A) Use the same weights for the benchmark as the manager.

B) Calculate the historical mean and standard deviation for the benchmark.

C) Identify the manager’s investment process.

---

Although calculating the historical mean and standard deviation for the benchmark is something that many portfolio managers will do, it is not specified as one of the steps in the construction of a custom security-based benchmark.

burning0spear

Which of the following statements best describes the steps required to construct a custom security-based benchmark?

A) Identify the manager’s investment process including asset selection and weighting; use representative assets and long run average weightings for the benchmark; assess and rebalance the benchmark on a predetermined schedule.

B) Identify the manager’s investment process including asset selection and weighting; use the same assets and weighting for the benchmark; assess and rebalance the benchmark on a predetermined schedule.

C) Identify the manager’s investment process including asset selection and weighting; use the same assets as the manager and the long run average weighting for the benchmark; assess and rebalance the benchmark on a predetermined schedule.

---

The three steps required to construct a custom security-based benchmark are as follows:

1. Identify the manager’s investment process including asset selection and weighting.
2. Use the same assets and weighting for the benchmark.
3. Assess and rebalance the benchmark on a predetermined schedule.

burning0spear

Which of the following statements about style indexes is least accurate?

A) Some style indexes can contain weightings in certain securities and/or sectors that may be larger than considered prudent.

B) They are widely available, widely understood and widely accepted.

C) They help fund sponsors better understand a manager’s investment style, by capturing factor exposures.

---

Helping fund sponsors better understand a manager’s investment style, by capturing factor exposures is an advantage of factor models and not style indexes. The other statements are true in the context of style indexes.

burning0spear

All of the following would be regarded as a specific disadvantage of factor-based-models, EXCEPT:

A) it is possible to construct multiple benchmarks, all having the same factor exposures but with different returns.

B) the benchmark may not be investable.

C) the manager’s style may deviate from the style reflected in the benchmark.

---

The manager’s style may deviate from the style reflected in the benchmark is a weakness of broad based market indexes not factor-model-based benchmarks. The other statements are regarded to be disadvantages of factor-model-based benchmarks.