Questions 19 to 24 relate to Equity Portfolio Management
Sonera Endowment Fund Case Scenario
William Gatchell, CFA, is an investment analyst with the Sonera Endowment Fund. Sonera is considering
hiring a new equity investment manager. In preparation, Gatchell meets with Anjou Lafite, another
analyst at the fund, to review a relevant part of the endowment’s investment policy statement:
“Funds will be invested in the most efficient vehicle that meets the investment objective. Each manager
must demonstrate the efficiency with which the tracking error they take on delivers active return. In
addition, each manager must consistently adhere to his stated style.”
Gatchell is given the task of reviewing three investment managers and selecting a manager that is most
likely to adhere to Sonera’s investment policy statement. Information about the investment managers is
found in Exhibit 1.
Exhibit 1
Investment Manager Data
Investment Manager
A B C
Assets under management ($ millions) 1,325 3,912 524
Information ratio –0.27 0.50 0.75
Small-cap value index– beta 0.95 0.98 1.05
Small-cap growth index– beta 0.32 0.43 0.48
Large-cap value index – beta 1.05 1.10 0.96
Large-cap growth index – beta 0.47 0.39 0.37
Manager stated style Value Value Growth
Manager stated sub-style Low P/E High yield Momentum
Gatchell is reviewing the fee structures proposed by the three investment managers. He finds the
following reference in the investment policy statement:
“The fee structure must be easy to understand and avoid undue complexity wherever possible. Also, the
fee structure must be predictable, so Sonera can reasonably forecast these costs on a yearly basis as an
input to the annual budgeting process.”
He understands there are many different fee structures, and he wants to make sure he chooses the
most appropriate one for the Sonera Endowment Fund. He prepares a recommendation to the
investment policy committee regarding the most appropriate fee structure.
Sonera has followed an active investment style for many years. Gatchell would like to recommend to the
investment policy committee that a portion of the funds be invested using a passive investment style.
His research shows there are a number of methods used to weight the stocks in an index, each having its
own characteristics. The one key feature he feels is important is that the method chosen not be biased
towards small-capitalization stocks.
Gatchell is also examining different ways to establish passive equity exposure. He states to Lafite, “There
are a number of ways to get passive equity exposure; we can invest in an equity index mutual fund, a
stock index futures contract, or a total return equity swap. Stock index futures and equity swaps are
low-cost alternatives to equity index mutual funds; however, a drawback of stock index futures is they
have to be rolled over periodically. One advantage of investing in equity mutual funds is that shares can
be redeemed at any point during the trading day.”
Gatchell is reviewing the performance of another investment manager, Far North, which employs a
value-oriented approach and specializes in the Canadian market. Gatchell would like to recommend to
the investment policy committee that the fund diversify geographically. The information for Far North
and the related returns are found in Exhibit 2.
Exhibit 2
Far North: Return Information
Rate of Return
Far North 14%
True active return –1%
Misfit active return 5%
The investment policy committee reviews the information in Exhibit 2 and is not familiar with the terms
true active return and misfit active return. Gatchell responds with the following statement:
“The true active return is the return Far North made above its normal benchmark return. The misfit
active return is the return Far North made above the investor’s benchmark return. The term investor’s
benchmark refers to the benchmark the investor uses to evaluate performance for a given portfolio or
asset class.”
19. Based on Exhibit 1, which investment manager most likely meets the criteria established in the
endowment’s investment policy statement?
A. Manager A
B. Manager B
C. Manager C
20. Based on Exhibit 1, is there sufficient information for Gatchell to create and interpret the results
of a style box?
A. Yes
B. No, because additional index data are required
C. No, because additional holdings data are required
21. Which fee structure is most appropriate for Sonera based on the criteria in the investment
policy statement?
A. An ad valorem fee structure
B. A performance-based fee structure with a fee cap
C. A performance-based fee structure with a high water mark
22. If the investment policy committee decides to accept Gatchell’s recommendation to also use
passive investing, the index structure that least likely meets Gatchell’s requirement is:
A. a price-weighted index.
B. a value-weighted index.
C. an equal-weighted index.
23. In his statement to Lafite, Gatchell is least likely correct with respect to:
A. cost.
B. redemption.
C. periodic rollover.
24. Is Gatchell’s statement regarding true active return and misfit active return correct?
A. Yes
B. No, he is incorrect about true active return
C. No, he is incorrect about misfit active return
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