RIA Performance Reporting & Benchmarking 2 — Questions and Answers
Question 1: The Sharpe ratio of a portfolio is calculated as which of the following?
- (Portfolio Return – Benchmark Return) / Tracking Error
- (Portfolio Return – Risk-Free Rate) / Standard Deviation (Correct answer)
- (Portfolio Return – Risk-Free Rate) / Beta
- Alpha / Residual Risk
Correct answer: (Portfolio Return – Risk-Free Rate) / Standard Deviation
The Sharpe ratio equals (Portfolio Return – Risk-Free Rate) / Standard Deviation, measuring excess return per unit of total volatility.
Question 2: In investment performance attribution, 'alpha' most accurately refers to:
- The portfolio's total return over the measurement period
- The excess return of a portfolio above what would be predicted by its level of systematic risk (Correct answer)
- The difference between gross and net of fees returns
- The portfolio's standard deviation relative to the benchmark
Correct answer: The excess return of a portfolio above what would be predicted by its level of systematic risk
Alpha represents the portion of a portfolio's return not explained by systematic risk (beta), indicating skill or luck in active management.
Question 3: Which type of benchmark is most commonly used for domestic large-cap equity portfolios in the United States?
- Custom liability-based benchmark
- S&P 500 Index (Correct answer)
- Bloomberg Aggregate Bond Index
- MSCI EAFE Index
Correct answer: S&P 500 Index
The S&P 500 is the most widely used benchmark for domestic large-cap U.S. equity portfolios, representing the 500 largest publicly traded U.S. companies.
Question 4: Performance attribution analysis is primarily used to:
- Determine a client's risk tolerance score
- Identify the sources of a portfolio's return relative to its benchmark (Correct answer)
- Calculate the portfolio's after-tax return
- Establish the minimum return required to meet a client's goals
Correct answer: Identify the sources of a portfolio's return relative to its benchmark
Performance attribution decomposes active return into components (e.g., allocation, selection, interaction) to explain why a portfolio outperformed or underperformed its benchmark.
Question 5: The information ratio is best described as:
- Active return divided by tracking error (Correct answer)
- Portfolio return divided by standard deviation
- Excess return divided by beta
- Benchmark return divided by portfolio return
Correct answer: Active return divided by tracking error
The information ratio equals active return (portfolio return minus benchmark return) divided by tracking error (standard deviation of active returns), measuring consistency of outperformance.
Question 6: Under GIPS, what is a 'carve-out'?
- A portion of a multi-asset portfolio managed separately as a standalone segment (Correct answer)
- The removal of underperforming accounts from a composite
- A benchmark constructed to match a specific portion of a composite
- An audit exemption for small firms
Correct answer: A portion of a multi-asset portfolio managed separately as a standalone segment
A carve-out is a subset of a larger portfolio representing a distinct investment strategy, which may be used in composites under specific GIPS conditions including that it must be managed with its own cash balance.
Question 7: To initially claim GIPS compliance, a firm must present at minimum how many years of compliant performance history?
- 1 year
- 3 years
- 5 years (Correct answer)
- 10 years
Correct answer: 5 years
Firms initially claiming GIPS compliance must present a minimum of 5 years of compliant performance, or since inception if less than 5 years, and then build toward a 10-year record.
RIA Performance Reporting & Benchmarking 2
The Sharpe ratio of a portfolio is calculated as which of the following?