Not really clear as how to think about this approach. So each layer of the analysis represents an investment strategy ? Not sure, Can anyone explain ?
Each layer represents sources of return for the incremental risk you are taking. It starts with the diff of ending portfolio value, beginning portfolio value and breaks down where the change came from.
thanks for that . So how would this be applied in a real world example if your the fund sponsor ?
This lets a fund sponsor evaluate whether each additional level of analysis / risk taking is giving him additional return or not. it also gives him feedback on his performance broken down / attributed to different sources.
Separate question - can we assume that we do NOT need to know the various equations applied to find the return at each level (eg: Asset category, benchmark, investment manager)? I’ve only got so much spare capacity in my head - dropping those equations would save me a lot of real estate!
to remember the 6 different layers (or sources) of incremental returns - try “ChaRiSMA” (as in: fund managers have no Charisma): C = cash contributions (ie just sit on the cash - don’t invest it) R = Risk Free Rate (just invest at the RFR) I = Index - invest in just the broad market Index for that particular asset class S = Style - incremental return from the mgr’s Style benchmark M = Mgr return = manager’s actual return (over & above the Style BM) A = Allocation - returns from from tactical allocation being different from Policy allocation the first 3 are passive, the last 3 are active (applogies if this has been done before, but I found it easy to remember…)
null&nuller: Thanks for sharing.
An additional question. How do we delineate between the different levels in this hierarchy of investment strategies ? Or do we just plug in know known variables such as rates (eg risk free rates, allocation misfits) to break out the various impacts in a sequential manner? I am assuming we are analyzing a fund over a given period of time to allocate the various effects.
the LOS just says: (k) “distinguish between”… macro & micro (l) “demonstrate, justify, and contrast” …macro & micro so, aside from contrasting and justifying macro, etc - as far as calcs go (“demonstrate”) - it looks like you just need to be able to tell what are the major sources of return (given a table of results), or maybe do a build-up of either the dollar value or %returns. Or split into Style -v- Skill (or RFR or passive index for that matter) - based on the given output. Maybe compare sources of return for 2 funds given the CRISMA table outputs Fortunately the Macro calcs have no “weighting” calcs - that’s where the fund starts (in Micro)
cfa09: We don’t analyze a fund. Macro is used at sponsor level. More like an endowment which makes investments.
Thankyou
I am trying to move on from this but had another question. My understanding is that this analysis is trying to delineate how much incremental value is being added by each level in the hierarchy of decisions here. However, aren’t these choices mutually exclusive ? That is , we either hold total funds in cash or invest with active managers or index etc. So how do we decompose any fund performance into all these parts when the money has to be invested in one or the other of these ? Can someone clarify ?
Let’s say the sponsor has a broad US Equity market mandate. Let’s say the following are ex-post returns for the period (say 1 year): C = cash = ie starting balance = ending balance assuming no net CF in R = RFR = say 5% I = index fund for whole asset class = 6% (eg S&P500) S = Style benchmark = 7% (eg big cap value) - for say 30% Policy allocation of total funds M = Manager’s actual return = 7.5% A = Allocation returns (when different from the investor’s Policy allocations = say 8% (eg if the sponsor had a tactical allocation to equities of say 40% instead of the policy 30%) So if the fund sponsor gave 40% of the total fund to a big cap value manager (instead of the Policy 30% allocation), and the total portfolio achieved 8.0%, then this total return is made up of: C = starting cash = 0% return RFR = 5% class index (US Equities) incremental return = 6% - 5% = 1% Style return (US big cap value) = 7% - 6% = 1% Manager’s active return = 7.5% - 7% = 0.5% Allocation return (ie impact of allocating 40% of the fund to US big-cap Value instead of just the Policy 30%) = 8% - 7.5% = 0.5% So, 5.0% + 1.0% + 1.0% + 0.5% + 0.5% = 8% (i have simplified it by only looking at the big-cap value manager. There would be other managers managing the other 60% of the total portfolio, and their returns would factor in to the total portfolio return) The US big-cap value manager added just +0.5% of the total return (via skill or luck). But the sponsor added: +1.0% from his Policy allocation decision to invest in US Equities +1.0% from his decision to allocate the Policy 30% to US big-cap value style +0.5% from his decision to over-weight US big-cap value sector (+ I suppose you could say that the sponsor also added the 5% RFR in value because the RFR is a no-brainer, and not an option anyway under his mandate in this case) By breaking it down, the different layers (strategies) are not mutually exclusive, they are incremental. If on the other hand he just invested in the S&P index ETF, then you would only go as far as step 3 (CRI) and the return would be broken down into: C = starting cash = 0% return RFR = +5% I = index fund = +1% = total 6% return Hope this helps - sorry for the long example.
That’s great null. Much clearer now. Thanks