) CORTEZ’S COMMENT WITH REGARD TO THE TWO DIFFERENT APPROACHES TO ECONOMIC ANALYSIS IS MOST LIKELY

6.) Cortez’s comment with regard to the two different approaches to economic analysis is

most likely:

A.

incorrect because of the statement regarding leading indicators.

B.

correct.

C.

incorrect because of the statement regarding econometrics.

Answer = B

Cortez’s statement is entirely correct. A disadvantage of the leading indicators–based

approach is that historically, it has not consistently worked because relationships

between inputs are not static. An advantage to the econometric approach is that it

provides quantitative estimates of the effects on the economy of changes in exogenous

variables.

“Capital Market Expectations,” by John P. Calverley, Alan M. Meder, Brian D. Singer, and

Renato Staub

Sections 4.5.4

Arcadia

Arcadia, LLP, is one of several independently operated investment management subsidiaries of

Swiss Corp, a global bank. Arcadia is headquartered in Philadelphia, Pennsylvania, and

specializes in the management of equity, fixed income and real estate portfolios. Arcadia’s CEO

recently hired Joan Westley, CFA as chief compliance officer to achieve compliance with the

Global Investment Performance Standards (GIPS). Arcadia just opened a division in Phoenix,

Arizona, incorporated as Arcadia West, LLP, to accommodate one of its portfolio managers and

his staff who manage a hedge fund. The staff in Phoenix works exclusively on the hedge fund’s

strategy, using an investment process distinct from the one used in the Philadelphia office.

Westley makes the following statement at a meeting with the CEO: “I am establishing and

implementing policies and procedures to ensure Arcadia is in compliance with the GIPS

standards. Although the hedge fund won’t be in compliance, it won’t affect our ability to be

compliant firm-wide, because it is in an autonomous unit. We will be the first Swiss Corp

subsidiary to be compliant. Keep in mind that even after implementation, we will not be able to

claim compliance until our performance measurement policies, processes, and procedures are

verified by an independent firm.”

Westley begins her review of Arcadia’s current policies. She first reviews three policies regarding

input data:

Policy 1: The accounting systems record the cost and book values of all assets. Portfolio

valuations are based on market values, provided by a third-party pricing service.

Policy 2: Transactions are reflected in the portfolio when the exchange of cash,

securities, and paperwork involved in a transaction is completed.

Policy 3: Accrual accounting is used for fixed-income securities and all other assets that

accrue interest income; dividend-paying equities accrue dividends on the ex-dividend

date.

Next, Westley reviews Arcadia’s policies for return calculation methodologies:

Policy 4: Arcadia uses the Modified Dietz method to compute portfolio time-weighted

rates of return on a monthly basis. Returns for longer measurement periods are

computed by geometrically linking the monthly returns.

Policy 5: Arcadia revalues portfolios when capital equal to 10% or more of current

market value is contributed or withdrawn. Returns are calculated after the deduction of

trading expenses.

Policy 6: Cash and cash equivalents are excluded in total return calculations. Custody

fees are not considered direct transaction costs.

Westley also looks at the investment policy statements (IPS) for the three sample portfolios that

are included in Arcadia’s large-capitalization equity composite:

Portfolio A: A portfolio managed for a local church in which all fees are waived. The IPS

prohibits holdings of companies involved in firearms, alcohol, or tobacco. These

securities represent 5% of the benchmark, but the portfolio manager believes he can

still implement his strategy with these restrictions.

Portfolio B: The equity carve-out portfolio of a balanced account. The client provides

Arcadia discretion in the tactical asset allocation decision. Asset allocation among

subportfolios is performed quarterly and each subportfolio holds tactical or frictional

cash.

Portfolio C: A large-cap equity mutual fund managed for a corporate retirement plan.

Employees can make contributions and withdrawals daily. The client requires the

portfolio manager to maintain at least 15% of assets in cash balances to meet potential

withdrawals.

Finally, Westley examines a recent presentation to a prospective client regarding Arcadia’s

small-cap composite. Details of this presentation are presented in Exhibit 1 and its notes.

Exhibit 1: Small-Capitalization Equity Composite

Benchmark: Russell 2000

Gross of

Total Assets

Net of

Internal

($ millions)

Benchmark

Number of

Fees

Dispersion

Year

Return

Return (%)

Portfolios

(%)

Composite

Firm

2009

4.2

3.2

3.7

4

3.3

100

1,000

2010

3.7

2.7

7.0

9

4.6

225

1,250

2011

–1.0

–2.0

–4.5

7

1.7

350

900

2012

9.3

8.3

12.0

12

2.8

425

1,050

1Q13

5.2

4.9

–7.0

14

3.6

620

1,125

Notes: