This is a bit more technical, as I just said, but for one simple reason.
Here we're going really into the details to find out
whether a manager is really doing what he says he's doing.
For that, we will see that various ways to measure this performance attribution.
The first one is focus on fundamentals.
We do some kind of regression, we estimate the portfolio returns on various factors.
Here I indicated some, the P/E ratio, remember we saw that when we
studied the how to value an asset or an equity market.
And we'll also look at the economy.
We'll also look at the duration of bonds.
You remember duration, the ruler.
[LAUGH] And the glasses and the bottle that fell.
Anyway, so that's the sensitivity of your bond to the movements in interest rates.
And so, basically we take all these factors and
we see how a portfolio is linked to these various factors.
And then we're able to say, okay,
maybe 60% of these returns come from strategies on the PEs.
The manager will be some kind of value investor,
buying when the PE is low and selling when the PE is high.
Or possibly would also take bets on the bond market and by extent duration.
When he expects interest rates to drop and conversely, so things are like that.
Then the second way to measure performance decomposition
is something which is more widely used.
And it's also [LAUGH] By William Sharpe, so Sharpe Ratio, widely used.
And style analysis also by William Sharpe is also widely used.
And the style analysis, it's the same kind of spirit as in the previous one,
the multi factor analysis.
But here we tend to focus on specific styles.
For instance, value, typically and also small versus large caps.
So, here we would want to see if a manager pretends he is
a value investor and he specialize on small cap.
Then we will see, we will make a regression of the portfolio return,
the fund return on two indices.
Which capture this value style, and also the small cap versus large cap style.
And we'll see how the fund correlates with these two factors to see
if there's really a strong correlation.
A high correlation between the value style,
the small cap style and the returns of the fund manager.
And lastly, we also have a return decomposition to find out
how much in a portfolio comes from in the terms of returns,
comes from the top-down approach.
Remember the top-down you start from the global microeconomic picture.
Then you derive some views on the sectors to over under-weight and then the stocks.
And the bottom-up perspective which starts from the bottom.
Identifies the companies for their fundamentals and
their attractive valuation and builds the portfolio from the bottom.
And basically, here the decomposition will come with a result and say okay.
For this kind of portfolio, we can say that maybe 2/3 of the returns
come from the asset allocation decision, the market timing, the top-down bit.
And only 1/3 comes from individual security selection.
So, here and maybe also a fund manager which pretends he is a good stock picker.
Well, actually, the results will show that he makes more money with market timing,
as opposed to stock selection.
So, this performance attribution is more technical but
indeed is key also when we are dealing with fund management.
Because here we really want to make sure that as we say,
the manager puts his money where his mouth is.
He does what he claims he is good at.
So, we want to check for instance, if he's good at picking stocks,
if he's good at market timing, if he's a value investor or small cap specialist.
What else?
Avoiding losses.
This is more for the hedge fund type of manager because
here we are in an absolute return environment.
Where the fund manager should deliver positive returns,
normally irrespective of market conditions.
Irrespective of what the benchmark is delivering, return-wise.
And also connected to this hedge fund strategies,
we want to see if the hedge fund manager makes money on his short positions.
And the short book is not just a hedge book of the long positions,
but also something which delivers a positive alpha.
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