Performance Measurement and Attribution Flashcards

Which return measure eliminates the distorting effect of external cash flows and is most appropriate for evaluating investment manager performance?

Answer: Time-weighted return

Time-weighted return removes the impact of the timing and size of external cash flows, making it the standard for comparing manager performance across firms.

A portfolio is worth £100,000 at the start of the year. After six months it grows to £110,000 before an additional £20,000 is invested. By year end the portfolio is worth £143,000. What is the approximate time-weighted return for the year?

Answer: 21.0%

Sub-period 1: £110,000/£100,000 − 1 = 10%; Sub-period 2: £143,000/£130,000 − 1 = 10%; TWR = (1.10 × 1.10) − 1 = 21%.

A portfolio achieves a return of 12% while its benchmark returns 9%. What is the active return?

Answer: 3%

Active return (alpha) = portfolio return − benchmark return = 12% − 9% = 3%.

Which of the following is NOT a characteristic of a valid performance measurement benchmark?

Answer: Chosen retrospectively to match the best-performing index that year

A valid benchmark must be specified in advance; selecting it retrospectively to flatter results violates the principle of objectivity.

An investor purchases a share for £50, receives a dividend of £2 during the year, and sells the share for £55. What is the holding period return?

Answer: 14%

Holding period return = (ending price − beginning price + income) / beginning price = (£55 − £50 + £2) / £50 = 14%.

A portfolio records quarterly returns of 3%, 2%, −1%, and 4%. What is the approximate annual time-weighted return?

Answer: 8.2%

(1.03 × 1.02 × 0.99 × 1.04) − 1 ≈ 1.0817 − 1 = 8.17%, closest to 8.2%.

The money-weighted return (MWR) is mathematically equivalent to which financial measure?

Answer: Internal rate of return (IRR)

The MWR is the discount rate that equates the present value of all cash inflows and outflows, which is the definition of IRR.