Quantitative Methods & Statistics for Fund Management Flashcards

Why is the geometric mean return preferred over the arithmetic mean for multi-period performance reporting?

Answer: Geometric mean accounts for compounding while arithmetic mean does not

The geometric mean (CAGR) accounts for compounding of returns over multiple periods and is always ≤ the arithmetic mean, making it the standard for multi-period performance measurement.

What is the primary limitation of using historical volatility to forecast future portfolio risk?

Answer: Historical volatility assumes past patterns of return dispersion will repeat in the future

Historical volatility assumes past return distributions will persist, but market conditions change, so past volatility may not accurately predict future risk — especially during regime shifts.

Which method is most commonly used to assess whether a fund manager generated genuine alpha after controlling for systematic risk?

Answer: Jensen's alpha from CAPM regression

Jensen's alpha is the intercept from a CAPM regression of fund returns on market returns; a statistically significant positive alpha indicates excess return beyond what systematic risk exposure would predict.

What does a tracking error of 4% indicate for an active equity fund manager?

Answer: The annualized standard deviation of the fund's active returns versus the benchmark is 4%

Tracking error is the annualized standard deviation of the difference between portfolio returns and benchmark returns; 4% tracking error means active returns vary around the benchmark by about 4% per year.

What does the Information Ratio measure in active fund management?

Answer: The consistency of alpha generation per unit of tracking error

The Information Ratio divides active return (alpha) by tracking error, measuring how consistently a manager generates excess returns per unit of active risk taken relative to the benchmark.

A fund manager wants to determine whether their strategy's alpha is statistically significant. Which test is most appropriate?

Answer: t-test on the regression intercept (alpha)

A t-test on the regression intercept (alpha) from a factor model tests whether alpha is statistically significantly different from zero, providing evidence of genuine manager skill.

What is the key advantage of bootstrapping over traditional parametric methods in fund performance analysis?

Answer: It does not require assumptions about the underlying return distribution

Bootstrapping is a non-parametric resampling method that avoids normality and other distributional assumptions, making it robust for return distributions exhibiting fat tails or skewness.