) CORTEZ’S COMMENT WITH REGARD TO THE TWO DIFFERENT APPROACHES TO EC...

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. 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: