Any other explanations as to why VAR is more useful than standard deviation in evaluating new managers and new portfolio strategies? I don’t see how standard deviation requires several years before the managers return history is available?
This is my reason: It’s similar to saying npv is better than irr. Apart from the multiple benefits of npv, it gives you the value unlike a percentage like irr. Similarly, VaR gives a loss as the result than a % like SD. It’s an absolute number which makes it a better comparable than a % figure. Check out the net for why percentages may not be the right comparison metric! Hope this answer is satisfactory
But why does standard deviation typically require several years before the managers return history is available, which limits its use in determining the effectiveness of new managers and strategies. VAR also requires past returns?
I think a key point here is that VAR is typically used for short term periods of risk analysis. While you can calculate annual VAR, most of the time is used monthly, weekly, daily. I don’t know where the question is from and can’t reference the answer key, but that would be my best guess, and probably what I would answer.
I too thought abt that but realized later that you still need the standard deviation input. You might have an annualized SD input which you convert to a daily, weekly etc figure. And taking SD of little data (without a sufficient sample) is sort of misleading.
you also do not evaluate a manager based on the volatility (std deviation) of returns produced. You evaluate him based on whether he generates profits / losses - and for that VAR is the right number.
Std Deviation is a % number - while VAR is easily convertible to the $ profit / loss.
In theory to calculate an analytical VaR you don’t actually need any money manager performance history, all you need is price history for the assets currently held in the portfolio. Analytical VaR is based on historical prices of individual securities held in a portfolio at a point in time. On day one of a new strategy, if the manager buys some equities and holds them for a second, a parametric/analytical VaR can be easily calculated, whereas the standard deviation of money manager returns can not as there is no manager performance history. In terms of VaR, only an historic VaR requires a money manager track record to exist before being calculated. Even a Monte Carlo simulated VaR can be calculated without a money manager track record.
So this is surely why VaR is more useful that standard deviation when assessing new money managers.
The answer given in the OP “Answer: standard deviation typically requires several years before the managers return history is available, which limits its use in determining the effectiveness of new managers and strategies.” states they are concerning themselves with the standard deviation of the managers returns, not the standard deviation of the portfolio holdings - two very different things!
True, but the same limitations apply to VaR in this case. I think the answer is tricky in itself, both are not a good measure. But saying standard deviation is better is still correctly false. If that makes sense.
Totally agree it’s an awful, awful question and definitely wouldn’t be found in a real CFAI exam no doubt. I was just trying to get the best answer to an awful question.
But I disagree that the same limitations apply to VaR - read my previous post. You can calculate a VaR on day 1 of a new portfolio - you can’t calculate the standard deviation of returns on day one of a new portfolio. That is just explicitly true.
No - I think you are misunderstanding what analytical/parametric VaR is and how it is calculated. It is calculated using the historic standard deviations/returns/covariances and correlations between the assets held in the portfolio AT A POINT IN TIME.
If you are talking about historic VaR then I agree with you. But I am not - I am talking about analytical/parametric VaR
All you need are price histories for the assets held in your portfolio, and you can calculate your VaR - there is no issue of “small sample size” as you are using full, real price histories of the assets held in your portfolio.
On day 1, you can get a full VaR reading back for any time frame for which you have individual asset price histories. Again, there is absolutely no small sample size issue with parametric VaR.
Oh, I thought you meant the price performance and correlations for that holding period only. In this case, the manager can be heavily active in management, so it’s pointless either way. Remember that we’re talking about the manager’s performance, and not the portfolio risk at a point in time.
On topic, you could still calculate the SD of the portfolio held at that point in time, using the historic standard deviations. That doesn’t provide an advantage over normal conditions.