THROUGH 30 RELATE TO PERFORMANCE ATTRIBUTION. MALCOLM O’K...

Question

Questions 25 through 30 relate to Performance Attribution. Malcolm O’Kelly Case Scenario Malcolm O’Kelly is a performance evaluation consultant working for the Board of Trustees of the Rutherford University (RU) Pension Fund.  The Board has asked O’Kelly to conduct a macro attribution analysis for the pension fund.  O’Kelly gathered the data shown in Exhibit 1 and Exhibit 2.  The one-month return on a U.S. Treasury bill is 0.41 percent. Exhibit 1 RU Pension Fund Investment Policy Allocations and Benchmark Assignments Asset Category  Policy Allocations  Benchmark Domestic equities S&P 500 70%    Large-cap Growth Index 60%    Equity Manager A 40%    Equity Manager B    Large-cap Value Index Lehman Govt./Credit Index 30% Domestic fixed income    Lehman Int’l. Govt./Credit Index    Fixed-income Manager C 65%    Lehman Treasury Index 35%    Fixed-income Manager D Exhibit 2 RU Pension Fund One-month Actual and Benchmark Returns Asset Category  Actual Return  Benchmark Return 4.46% 4.55% 4.61% 4.84% 4.31% 4.10% 2.56% 2.32% 1.72% 1.99% 2.55% 3.43% 3.90% Total Fund 3.94% The Board is considering adding Cottonwood Equity Advisors as their third domestic equity manager.  In their proposal to the Board, Cottonwood claims to generate positive alpha by overweighting sectors that they expect will outperform the overall benchmark portfolio.  Cottonwood also attempts to enhance overall return by overweighting securities their analysts have identified as undervalued.  The Board asked O’Kelly to perform a micro attribution analysis of Cottonwood’s equity portfolio.  O’Kelly’s analysis is shown in Exhibit 3. By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to Exhibit 3 Micro Attribution Analysis for Cottonwood Equity Advisors Portfolio Performance Attribution Sector BenchmaTotal PortfolPure Within AllocatioValuio rk rk Return n/ Economic Weight e- Return (%) Selection SelectiSectors Addeon Interactid 8.7 0.061 0.033 –0.002 0.030 –3.60 9.3 –3.95 Capital goods Consumer 0.025 1.77 36.2 40.6 –0.007 nondurables 1.92 –0.029 0.001 0.017 0.005 –0.021 0.14 Energy 9.5 0.37 7.3 24.3 –0.004 0.202 2.92 2.05 23.8 –0.005 0.211 Financial 20.5 0.130 0.014 0.147 0.004 18.5 Technology 1.30 2.00 0.002 0.0 Cash/equivale1.3 –0.014 0.000 –nts 0.012 100.0  100.0  1.52 1.10  –0.035  0.008  0.451  0.424 Buy/hold + cash –0.15 Trading & other     1.37  1.10  0.27 Total portfolio The discussion then turns to fixed-income attribution analysis.  Board member Carolyn Tripp asks O’Kelly about the determinants of fixed-income portfolio returns.  O’Kelly responds that fixed-income portfolio returns can be attributed to an external interest rate effect and the management effect.  Then Tripp asks O’Kelly about analyzing the management effect.  O’Kelly responds that the management effect can be decomposed into the following components: •  Interest rate management effect: indicates how well the manager predicts interest rate changes.  Each security must be priced as a default-free security.  Then the Treasury bill rate is added to the returns on the repriced securities to obtain the interest rate management effect. • Sector/quality effect: measures the manager’s ability to select outperforming sectors and quality groups.  The sector/quality return is estimated by repricing each security in the portfolio using the average yield premium in its respective category.  A gross return can be then calculated based on this price.  The return from the sector/quality effect is calculated by subtracting the external effect and the interest rate management effect from this gross return. Security selection effect: measures how the return on specific securities within a sector relates to the average performance of the sector.  The security selection effect for each security is the total return for that security less all the other components.  The portfolio’s security selection effect is the arithmetic average of all the individual security selection effects. •  Trading activity : measures the effect of sales and purchases of securities and is calculated as the total portfolio return less all the other components. 25. Based on a macro attribution analysis of the information given in Exhibits 1 and 2, the incremental return contribution attributed to the Asset Category investment strategy is closest to: A.  –0.09%. B.    3.48%. C.    3.89%. 26. Based on a macro attribution analysis of the information given in Exhibits 1 and 2, the incremental return contribution attributed to misfit return (i.e., style bias) is closest to: B.    0.08%. C.    0.32%. 27. Based on a macro attribution analysis of the information given in Exhibits 1 and 2, the incremental return contribution attributed to the investment managers is C.    0.49%. 28. Based on the micro attribution analysis presented in Exhibit 3, which part or parts of Cottonwood’s strategy most likely succeeded? A.  Sector selection. B.  Securities selection. C.  Neither securities nor sector selection. 29. O’Kelly’s descriptions of the interest rate management effect and sector/quality effect are most likely correct with respect to: A.  both effects. B.  the interest rate management effect but not the sector/quality effect. C.  the sector/quality effect but not the interest rate management effect. 30. O’Kelly’s descriptions of the security selection effect and trading activity are most likely correct with respect to: A.  both. B.  the security selection effect, but not the trading activity. C.  the trading activity, but not the security selection effect.