Portfolio Management Flashcards

Why is the time-weighted rate of return preferred for evaluating an investment manager?

Answer: It removes the effect of external cash flows the manager does not control

Time-weighted return chain-links sub-period returns, neutralizing the timing and size of client deposits and withdrawals.

In Brinson performance attribution, a manager overweights a sector that outperformed the overall benchmark. This produces a positive:

Answer: Allocation effect

The allocation effect rewards overweighting sectors whose benchmark return exceeded the total benchmark return.

Besides the market factor, the Fama-French three-factor model includes:

Answer: Size (SMB) and value (HML)

The three-factor model adds small-minus-big (size) and high-minus-low book-to-market (value) to the market factor.

An investor holds losing stocks too long and sells winners too early. This behavior is called:

Answer: The disposition effect

The disposition effect, rooted in loss aversion, leads investors to realize gains quickly and avoid realizing losses.

A risk-parity portfolio allocates capital so that:

Answer: Each asset class contributes equally to total portfolio risk

Risk parity equalizes risk contributions, typically overweighting low-volatility assets such as bonds, sometimes with leverage.

A stock whose expected return plots above the Security Market Line is considered:

Answer: Undervalued, because it offers more return than CAPM requires for its beta

Plotting above the SML implies positive alpha, so the stock is undervalued and its price should rise.

Tracking error is defined as:

Answer: The standard deviation of the difference between portfolio and benchmark returns

Tracking error measures active risk as the volatility of active returns relative to the benchmark.