CFA3’sPerspectiveØPerformanceevaluationimprovestheeffectivenessofafund’sinvestmentpolicybyactingasafeedbackandcontrolmechanismTheInvestmentManager’sPerspectiveØSomemanagerscomparetheirreportedinvestmentreturnstoadesignatedbenchmarkOthersinvestigatetheeffectivenessofeachcomponentoftheirinvestmentprocessperformanceevaluationPerformancemeasurementperformanceattributionperformanceappraisal1.PerformancemeasurementMethodsofcalculatingreturns1.1ReturnCalculations//Ifthereisanexternalcashflowatthebeginningoftheevaluationperiod/Ifacontribution/withdrawalisreceivedattheendftheevaluationperiod1.2Time-WeightedRateofReturn(TWR)()001MVMVCFMVrt--=()()CFMVCFMVMVrc++-=001CFA3:[]1)047.01)(095.01)(02.01(returnAnnualized1)047.01)(095.01)(02.01(TWR31--++=--++=1.3Money-WeightedRateofReturn(MWR)MWRModifiedInternalRateofReturnonallfundsinvestedduringtheevaluationperiod,includingthebeginningvalueoftheportfolioMV1=theendingvalueoftheportfolioMV0=thebeginningvalueoftheportfoliom=numberoftimeunitsintheevaluationperiodCFi=cashflowiL(i)=numberoftimeunits(days,etc.)cashinflowIisinorcashoutflowiisabsentfromtheportfolio1.4TWRvs.MWRTWRMWRAdvantagesDisadvantagesAdvantagesDisadvantagesUnaffectedbyexternalcash-flowactivity;Mostinvestmentmanagershavelittleornocontroloverthesizeandtimingofexternalcashflows.So,itmakessensetousearateofreturnmeasurementnotinfluencedbyexternalcashflow.Accountvaluationsarerequiredoneverydateanexternalcashflowtakesplace.Markinganaccounttomarketdailycanbeadministrativelymoreexpensiveandpotentiallymoreerrorprone.MWRismoreappropriateiftheinvestmentmanagermaintainscontroloverthetimingandamountoftheexternalcashflowsin/outoftheaccountOnlyrequiresanaccounttobevaluedatthestartandendoftheevaluationperiodMWRcouldbeheavilydistortedbythesizeandtimingofexternalcashflows(IRRiscompoundedbyeachperiod)Ifaninvestmentmanagerhaslittleornocontroloverthesizeortimingofexternalcashflows,theMWRwouldbenotbeasuitablemeasuretoevaluateperformance()()()()11...111321-++++=nrrrrTWR()())(10111iLinimRCFRMVMV+++=∑=CFA3ØSupposetheGF’sMWRiscalculatedeachweek.TheseMWRsare0.021inweek1,0.0016inweek2,-0.014inweek3,and0.018inweek4.TheLIRRisobtainedbylinkingtheserates:1)018.01)(014.01)(0016.01)(021.01(-+-++=LIRRTWRMWRTWRMWRLIRRWhencalculatingtheIRRforsmallsubperiods,accountingfornetcontributionsandfinallychain-linkingthem,theresultingreturnisaTWRapproximation.TheIRRcalculatedwiththesamedatasetoverthewholeperiodwillgiveaMWRandmostlikelyaverydifferentresult.TheBAIMethodisamethodologyforapproximatingTWRwiththeIRR.TheportfolioisvaluedeverytimeanetcontributionoccursandIRRiscalculated.Thetime-weightedperiodreturnsarederivedbychain-linkingtheIRR.IntheModified-BAIMethod,timeperiodsaresetindependentlyoftheoccurrenceofnetcontributions.Usually,monthlyorquarterlytimeperiodsarechosen.TheIRRisthencalculatedforeachmonthorquarterandchain-linked.Largecashflowslowerthequalityoftheapproximation.Itisthereforerecommendedtovaluetheportfolioduringthetimeperiodifthenetcontributionexceedabout10%oftheportfolio.TheMidpoint-BAIMethodalsousesfixedtimeperiods,butassumesthatnetcontributionsoccurinthemiddleoftheperiod.ComponentsofaportfolioreturnMarket,Style,ActiveManagementP=M+S+A=M+(B-M)+(P-B)PerformancebenchmarksValidbenchmarkUnambiguous:theidentitiesandweightsofsecuritiesconstitutingthebenchmarkareclearlydefined.Investable:itispossibleforindividualportfoliomanagerstoinvestinthesecuritiesconstitutingthebenchmarkMeasurable:thebenchmark’sreturnisreadilycalculableonareasonablyfrequentbasis.Appropriate:thebenchmarkisconsistentwiththemanager’sinvestmentstyleorareaofexpertise.Reflectiveofcurrentinvestmentopinions:themanagerhascurrentinvestmentknowledgeofthesecuritieswithinthebenchmark.Specifiedinadvance:thebenchmarkisspecifiedpriortothestartofanCFA3ØAdvantage:Simpleandstraightforwardbenchmark.ØDisadvantages:Notaninvestablealternative.ManagerUniversesmedianmanagerØAdvantage:Measurable.ØDisadvantage:Notspecifiedinadvance;Notinvestable;Notappropriate;SurvivorbiasBroadMarketIndexesS&P500ØAdvantages:ØWellrecognized,easytounderstand,andwidelyavailable.ØUnambiguous,generallyinvestable,measurable,andmaybespecifiedinadvance.ØDisadvantage:Manager’sstylemaybedifferentfromtheindexstyle(notappropriate).StyleIndexesS&P5001large-capgrowth2large-capvalue3small-capgrowth4small-capvalueØAdvantages:Widelyavaila