Performance Measurement and Reporting Flashcards

The Sortino Ratio improves upon the Sharpe Ratio primarily by:

Answer: Replacing total standard deviation with downside deviation in the denominator

The Sortino Ratio uses downside deviation (volatility of returns below a minimum acceptable return) instead of total standard deviation, reflecting that upside volatility is not a true risk for most investors.

The M-squared (M²) measure adjusts portfolio performance to:

Answer: Leverage or de-leverage the portfolio to match the benchmark's total risk level, then compare returns

M² scales the portfolio to have the same total risk (standard deviation) as the benchmark and computes the hypothetical return, enabling direct return comparison on a risk-adjusted basis.

Which of the following best defines 'active return'?

Answer: Portfolio return minus the benchmark return over the same period

Active return (also called excess return or alpha in the attribution context) is simply the portfolio's return minus the benchmark's return, representing the value added or subtracted by active management.

When presenting composite performance under GIPS, the dispersion measure reported alongside composite returns is intended to show:

Answer: The variability of individual portfolio returns within the composite for that period

GIPS requires a measure of internal dispersion (e.g., equal-weighted standard deviation) to show how consistently individual portfolios within the composite performed relative to the composite average.

A portfolio manager outperformed the benchmark by overweighting the technology sector, which subsequently rallied. In BHB attribution, this contribution is captured in the:

Answer: Allocation effect

The allocation effect captures the impact of deviating from benchmark sector weights; overweighting a sector that outperforms the overall benchmark produces a positive allocation effect.

Under GIPS standards, performance must be presented:

Answer: On both a gross-of-fees and net-of-fees basis

GIPS requires firms to present performance on both a gross-of-fees and net-of-fees basis so prospects can evaluate both manager skill and the real-world return after all investment management expenses.

Which of the following statements about 'portfolio attribution' is most accurate?

Answer: Attribution analysis decomposes total active return to identify the sources of outperformance or underperformance relative to a benchmark

Performance attribution breaks down a manager's active return into contributions from specific decisions (sector allocation, security selection, etc.) so clients and managers can understand what drove relative performance.