Baker case- Mock 2017 PM

Q 56- Given the under-performance of the small-cap fund, Baker and her assistants examine the investments being made in that fund. The fund holdings are primarily in stocks that trade infrequently and seldom have dealer quotes. Consequently, there is a concern that the small-cap benchmark may be inappropriate. Coates suggests using a custom security-based benchmark that has the following criteria: 1 broadly representative of the small-cap market, 2 includes a cash position weighting, and 3 weighted according to the market capitalization of infrequently traded small cap stocks.

The answer given:B is correct. Including a weight for a cash position, criteria 2, should be part of a custom benchmark. Broadly representing the small-cap market, criteria 1, and market capitalization weighted, criteria 3, may not be consistent with the small-cap manager’s approach

Why criteria 3 is not appropriate here?

market capitalization biased towards large cap in general, does not satisfy criteria 3. Interested to know reasoning behind 1 though

I think because of illiquid stocks?

Key feature of custom security benchmark is cash position weighting.

Can you please provide more details about "Key feature of custom security benchmark is cash position weighting"?


From Schweser:

The construction of a custom security-based benchmark entails the following steps:

Step 1: Identify the important elements of the manager’s investment process.

Step 2: Select securities that are consistent with that process.

Step 3: Weight the securities (including cash) to reflect the manager’s process.

Step 4: Review and adjust as needed to replicate the manager’s process and results.

Step 5: Rebalance the custom benchmark on a predetermined schedule.

Thank you!

Without having this in mind, I founded the question tricky as I did not see what a cash position may have to do there (even if of course, AM always have a cash position, from minor to x+% depending on the funds term and the regulation). Tricky…