cfai book6, p78, q13 manager’s expected return = 7.29% benchmark return = 7.11% manager’s actual return = 8.13% question: how much the return differential can be attributed to the value-added investment skill of the manager? (8.13 - 7.11) = 1.03. i would say the whole thing attributes to the manager’s skill. but, cfai says 1.03 - (7.29 - 7.11) = 0.84 attributes to manager’s skill. did anywhere in the book mention that expected outperformance doesn’t count?
I think the expected outperformance = 7.29-7.11=.18 is due to “style” differences which would be expected w/o value added skill.
The manager’s skill is measured relative to the manager’s own benchmark (which is, I guess, the manager’s expected return). The manager isn’t managing to the plan sponsor’s benchmark, but to his/her own defined BM (in practice, the manager might define a benchmark in conjunction with a plan sponsor, but in the idealized CFAI universe, the manager has his/her own benchmark). So, from the plan sponsor’s point of view, 0.84 comes from manager skill, and the remaining 0.18 is due to the fact that the manager’s benchmark outperformed the plan sponsor’s benchmark. If the manager had just bought an index replicating the manager’s benchmark (and thus not exercised any “skill” in chosing or timing stuff), the original plan sponsor would still have gotten 0.18% better than the sponsor’s originally intended BM. So that 0.18 portion of the total 1.04% is not considered part of manager skill, but is actually about the difference in benchmarks (which is usually considered a plan sponsor decision, because they decided to go with this manager knowing that the benchmarks are different). Is that any clearer?
i can see your point. but, based on cfai’s macro attribution framework, there are 6 value-added attribution categories from net contribution to investment manager to allocation effects. i dont see any category that can be used to hold this 18 bps. any idea?
You won’t. Those 6 value-added attribution categories are for the plan sponsors. In another words, those are high-level decisions, which a PM has nothing to do with. Your 18bps are really in micro-level (manager’s level). In another word, “Never mind that the firm lost $1billion, did you beat your goal?”
unfortunately, ws, this is a macro question. a large plan sponsor is evaluating his equity manager.
Well, then 5, investment manager. Pick a manager that can generate positive value-added portfolio.
but, the thing is when a sponsor evaluating a manager, will he use his benchmark or the manager’s benchmark?
manager’s benchmark. Try this…manager’s return=benchmark return + misfit return + true active return. This benchmark is investor’s benchmark.
thanks, this explains all
You must use the managers benchmark. If I have a portfolio (i’ll keep it simple) of a LC manager (60%), SC manager (10%), FI manager (20%), and Int’l Manager (10%) my overall portfolio benchmark might be a blend, 60% S&P, 10% R2000, 20% LB Agg, & 10% MSCI EAFE. Now I would evaluate the LC manger to teh S&P and not the Blended benchmark and then the SC to the R2000 and so on…does that make sense.
yap, the text on macro indeed mentioned that benchmark differential (level 4 value-adding) is manager’s bm vs asset category bm which is investor’s bm. i am all set. thanks,
manager’s return=benchmark return + misfit return + true active return that is correct misfit return is a return attributed to managers’ natural benchmark that differes from plan sponsor’s benchmark.
And here I thought Misfits were only from “Rudolph the Rednose Reindeer” movie! Why am I such a misfit? I am not just a nitwit. You can’t fire me I quit, since I don’t fit in. Why am I such a misfit? I am not just a nitwit. Just because my nose glows, why don’t I fit in?
comp_sci_kid Wrote: ------------------------------------------------------- > manager’s return=benchmark return + misfit return > + true active return > > that is correct misfit return is a return > attributed to managers’ natural benchmark that > differes from plan sponsor’s benchmark. I’m not sure this is correct. I think misfit risk comes from a manager’s deviation from their style benchmark. The misfit return then reflects the risk premium on active risk. In other words, misfit return is the additional return you expect from a manager for assuming more or less market risk (market defined as the style bm). If a manager’s portfolio has a beta of 1.1, you better hope the return is at least 10% more than their bm. The excess above that is true active return, or alpha, sweet alpha. If they only return 5% more than the bm, they have underperformed on a risk-adj basis. Which brings us full-circle to the original question…why the value-added investment skill of the manager is calculated by subtracting the bm return from the expected manager return, not the actual.
manager’s return = market return + style return + misfit return + true active return. Here
in the language of macro attribution. (confirming) asset category return = market return benchmark return = style return + misfit return investment manager return = true active return
I think that’s just about there. I need to confirm with the text but I think the investment manager return is broken down into misfit return + true active return. asset category return = market return (less rfr) benchmark return = style return investment manager return = misfit return + true active return Honestly, I think the text could have found less confusing names for some of these incremental return sources.