Interview Question

I was asked this question during an interview. What would be the optimal answer. “Many managers incorporate small cap equities (Canadian equity mandate) in their core equity portfolio to general extra return, many times these return represent the main source of alpha. How can you construct a research to find evidence that it is optimal to incorporate small cap in the portfolio. From a portfolio construction perspective” He also mention Risk Budget of 3.5%. I didn’t understand the question fully and obviously didn’t give a very good answer. What was he trying to get at and what wouldve been the optimal answer?

He also asked another question which I was unsure of. When conducting performance attribution on international equity for an example. would you include futures, what’s the difference. I didn’t understand that part fully either. but I know you would include futures to give a better reflection of the performance attribution.

whystudy Wrote: ------------------------------------------------------- > I was asked this question during an interview. > > What would be the optimal answer. > > > “Many managers incorporate small cap equities > (Canadian equity mandate) in their core equity > portfolio to general extra return, many times > these return represent the main source of alpha. > How can you construct a research to find evidence > that it is optimal to incorporate small cap in the > portfolio. From a portfolio construction > perspective” > > He also mention Risk Budget of 3.5%. > > I didn’t understand the question fully and > obviously didn’t give a very good answer. > > What was he trying to get at and what wouldve been > the optimal answer? Model Return vs Standard Deviation with and without small cap porfolio. Is it above the CAPM? What’s the Sharpe of the two? etc…

I think the inclusion of Sm. Caps into a core mandate is your basic portfolio diversification [i.e. improved risk adjusted returns]…Bob’s your uncle. With the futures question on Internationl Equities, I would assume that he means ex currency returns. The point here being that a manager who manages international equities for a Canadian customer doesn’t hide/mask their security selection skill set behind a weaken Loonie. That’s all I can think of… Willy

from a MPT perspective you could see what adding a SC % exposure does to the portfolio as far as efficient frontier. So you need data on historic returns/risk for both the existing portfolio and the SC, and see what effect it would have (ie-does it lead to a higher expected return, lower expected risk, etc)

Historically, there’s been a return premium for investing in small-cap equities. People don’t agree on why: some people think that it’s because small caps have a risk that is separate from standard market volatility and therefore they get paid for that, others think that there is survival bias from small caps that drop out of an index (kinda the flip side of point 1), others think that (and this seems most plausible to me) the largest funds can’t really afford to invest in small cap, and so there’s a liquidity premium for buying small caps (the flip side of a price discount for having fewer buyers). Of course, it can be a mixture of the three, and other reasons. So it’s mostly a portfolio optimization question. You might take historical returns and toss them into an optimizer and see if there is much value in having small caps in your portfolio. In terms of a risk budget, what they are asking about is how you would tune your portfolio allocation so that the tracking error to whatever benchmark they are using is no more than 3.5%.

Bob’s your uncle? huh? i don’t know why i blanked out… i should always think of risk and return, that wouldve main the whole question so much easier. i guess i was thinking too much and too into it. thanks

Under interview conditions, it can sometimes be hard to frame the question right for the answer. tvPM had a very simple and straightforward way to answer it. Under interview pressure, I often blank out and think “they can’t be asking something as simple as that, it’s got to be more complicated,” and then blurt out something more convoluted. Then, they either think I’m dumb or out-of-it, or they might think that I’m thinking through things in more depth, and be impressed. Hard to tell.

I find that with a lot of interviews, you tend to look too deeply into a question when most of the time the answer is a very straightforward client based one. “Better risk adjusted returns sir” is the answer to about 55% of my questions…the rest are trading/cost related. Willy

thanks guys… level 3 candidate and i know so little…

you know how to pass L2…and thats the question I am still working on. I’m sure it went better than you thought, and thanks for posting something of substance!

tvPM Wrote: ------------------------------------------------------- > you know how to pass L2…and thats the question I > am still working on. I’m sure it went better than > you thought, and thanks for posting something of > substance! There are two types of people who study for the CFA, those who study to pass the exam (i am guilty) and those who study and really learn the stuff. Because of work and the long hours, I have often just jumped on schweser and did practice exams, therefore not really learning truly all the concepts. I have a general idea and can often only give definitions upon a question. But today, reality hit me and I have promised myself that after the level 3 exam this june, I am goign to go abck and reread concepts in both level 1 and level 2. especiallyo the more interesting PM stuff. so reality is, i am not better off because i have passed level 2 or level 1 for that matter.

For Q2, I think if you don’t want currency exposure you can add futures to hedge currency risk. So the currency effect in the attribution would be minimized.

cfafrank Wrote: ------------------------------------------------------- > For Q2, I think if you don’t want currency > exposure you can add futures to hedge currency > risk. So the currency effect in the attribution > would be minimized. I didn’t understand what he was getting at. I just said we use a specific benchmark and since we are only analyzing long only managers, there was no need for incorporating futures into an EAFE analysis. I didn’t think he was asking in terms of currency, as I know that country allocation can be attributed to EAFE/Global performance measure, which in some sense would incorporate the currency effect.

I also find that with a lot of you Level 1 or 2 candidates who still live at home and don’t know what a woman is are more likely to spit out b.s. answers to pretty straightforward questions. Willy

WillyR Wrote: ------------------------------------------------------- > I also find that with a lot of you Level 1 or 2 > candidates who still live at home and don’t know > what a woman is are more likely to spit out b.s. > answers to pretty straightforward questions. > > Willy I am a level 3 candidate, who doesn’t live at home and know exactly how ladies are, and also worked in the industry for like 4 years, but still spit out BS. But let see if you are living at home Willy. here’s the question… How can I construct a study to see if a Canadian asset manager has capacity issues, and at what level do you think the manager will reach capacity.

whystudy Wrote: ------------------------------------------------------- > WillyR Wrote: > -------------------------------------------------- > ----- > > I also find that with a lot of you Level 1 or 2 > > candidates who still live at home and don’t > know > > what a woman is are more likely to spit out > b.s. > > answers to pretty straightforward questions. > > > > Willy > > > I am a level 3 candidate, who doesn’t live at home > and know exactly how ladies are, and also worked > in the industry for like 4 years, but still spit > out BS. > > But let see if you are living at home Willy. > > here’s the question… How can I construct a > study to see if a Canadian asset manager has > capacity issues, and at what level do you think > the manager will reach capacity. whystudy… aren’t you a level 1 candidate? Or do you just post there to talk ish? http://www.analystforum.com/phorums/read.php?11,905868

brianr Wrote: ------------------------------------------------------- > whystudy Wrote: > -------------------------------------------------- > ----- > > WillyR Wrote: > > > -------------------------------------------------- > > > ----- > > > I also find that with a lot of you Level 1 or > 2 > > > candidates who still live at home and don’t > > know > > > what a woman is are more likely to spit out > > b.s. > > > answers to pretty straightforward questions. > > > > > > Willy > > > > > > I am a level 3 candidate, who doesn’t live at > home > > and know exactly how ladies are, and also > worked > > in the industry for like 4 years, but still > spit > > out BS. > > > > But let see if you are living at home Willy. > > > > here’s the question… How can I construct a > > study to see if a Canadian asset manager has > > capacity issues, and at what level do you think > > the manager will reach capacity. > > whystudy… aren’t you a level 1 candidate? Or do > you just post there to talk ish? > > http://www.analystforum.com/phorums/read.php?11,90 > 5868 i post there to talk crap really… i am a level 3 candidate… i have been posting on the level 2 forum quite a bit last year and posted a bit on the level 3 forum as well this year.

i get bored at work and i like to see people go ape sh*t when i post stuff like that.

Eh he who smelt it dealt it alright whystudy. Willy