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TradeStrategyandExecution

Case:RobertHarding

?RobertHardingisaportfoliomanageratValleyRise,ahedgefund

basedintheUnitedStates.Hardingmonitorstheportfolioalongside

AndreaYellow,ajunioranalyst.ValleyRiseonlyinvestsinequities,but

Hardingisconsideringotherassetclassestoaddtotheportfolio,

namelyderivatives,fixedincome,andcurrencies.HardingandYellow

meettodiscusstheirtradingstrategiesandpricebenchmarks.

?HardingbeginsthemeetingbyaskingYellowaboutfactorsthataffect

theselectionofanappropriatetradingstrategy.YellowtellsHarding:

Statement1Tradingwithgreaterurgencyresultsinlowerexecution

risk.

Statement2Tradinglargersizeorderswithhighertradeurgency

reducesmarketimpact.

Statement3Securitieswithhighratesofalphadecayrequireless

aggressivetradingtorealizealpha.

?AfterfurtherdiscussionaboutYellow’sstatements,Hardingprovides

Yellowalistoftradesthathewantstoexecute.HeasksYellowto

recommendapricebenchmark.Hardingwantstouseabenchmark

wherethereferencepriceforthebenchmarkiscomputedbasedon

marketpricesthatoccurduringthetradingperiod,excludingtrade

outliers.

Case:RobertHarding

?Earlierthatdaybeforethemeeting,Yellowbelievedthatthemarket

hadunderreactedduringthepre-markettradingsessiontoastrong

earningsannouncementfromABCCorp.,acompanythatYellowand

Hardinghavebeenthoroughlyresearchingforseveralmonths.Their

researchsuggestedthestock’sfairvaluewas$90pershare,andthe

strongearningsannouncementreinforcedtheirbeliefintheirfairvalue

estimate.

Case:RobertHarding

?Rightaftertheearningsannouncement,thepre-marketpriceofABC

was$75.Concernedthattheunderreactionwouldbeshort-lived,

HardingdirectedYellowtobuy30,000sharesofABCstock.Yellowand

Hardingdiscussedatradingstrategy,knowingthatABCsharesarevery

liquidandtheorderwouldrepresentonlyabout1%oftheexpected

dailyvolume.Theyagreedontradingaportionoftheorderatthe

openingauctionandthenfillingtheremainderoftheorderafterthe

openingauction.Thestrategyforfillingtheremainingportionofthe

orderwastoexecutetradesatpricesclosetothemarketpriceatthe

timetheorderwasreceived.

?HardingandYellowthenshifttheirconversationtoXYZCorp.Harding

tellsYellowthat,afterextensiveresearch,hewouldliketoutilizean

algorithmtopurchasesomesharesthatarerelativelyliquid.When

buildingtheportfolio’spositioninXYZ,Harding’spriorityistominimize

thetrade’smarketimpacttoavoidconveyinginformationtomarket

participants.Additionally,Hardingdoesnotexpectadverseprice

movementsduringthetradehorizon.

Case:RobertHarding

?HardingandYellowconcludetheirmeetingbycomparingtrade

implementationforequitieswiththetradeimplementationforthenew

fixed-income,exchange-tradedderivatives,andcurrencyinvestments

underconsideration.YellowtellsHarding:

Statement4Smallcurrencytradesandsmallexchange-traded

derivativestradesaretypicallyimplementedusingthedirectmarket

access(DMA)approach.

Statement5Thehigh-touchagencyapproachistypicallyusedto

executelarge,non-urgenttradesinfixed-incomeandexchange-traded

derivativesmarkets.

Case:RobertHarding

?Thenextday,HardinginstructsYellowtorevisittheirresearchonBYYP,

Inc.Yellow’sresearchleadshertobelievethatitssharesare

undervalued.ShesharesherresearchwithHarding,andat10a.m.he

instructshertobuy120,000shareswhenthepriceis$40.00usinga

limitorderof$42.00.

?Thebuy-sidetraderreleasestheorderformarketexecutionwhenthe

priceis$40.50.Theonlyfeeisacommissionof$0.02pershare.Bythe

endofthetradingday,90,000sharesoftheorderhadbeenpurchased,

andBYYPclosesat$42.50.Thetradewasexecutedatanaverageprice

of$41.42.DetailsabouttheexecutedtradesarepresentedinExhibit1.

Exhibit1BYYPTradeExecutionDetails

Case:RobertHarding

?Whilethebuy-sidetraderexecutestheBYYPtrade,HardingandYellow

reviewValleyRise’stradepolicydocument.Afterreviewingthe

document,Yellowrecommendsseveralchanges:1)addapolicyforthe

treatmentoftradeerrors;2)addapolicythatensuresover-the-counter

derivativesaretradedonvenueswithrulesthatensureminimumprice

transparency;and3)alterthelistofeligiblebrokerstoincludeonly

thosethatprovideexecutionatthelowestpossibletradingcost.

Case:RobertHarding

?WhichofYellow’sstatementsregardingthefactorsaffectingthe

selectionofatradingstrategyiscorrect?

Greatertradeurgencyresultsinlowerexecutionriskbecausetheorder

isexecutedoverashorterperiodoftime,whichdecreasesthetimethe

tradeisexposedtopricevolatilityandchangingmarketconditions.In

contrast,lowertradeurgencyresultsinhigherexecutionriskbecause

theorderisexecutedoveralongerperiodoftime,whichincreasesthe

timethetradeisexposedtopricevolatilityandchangingmarket

conditions.

Case:RobertHarding

?GiventheparametersforthebenchmarkgivenbyHarding,Yellow

shouldrecommendabenchmarkthatisbasedonthe:

A.arrivalprice.

B.time-weightedaverageprice.

C.volume-weightedaverageprice.

Case:RobertHarding

?Solution:B.

HardingaskedYellowtoexecutealistoftrades,andhewantstouseaprice

benchmarkwherethereferencepriceforthebenchmarkiscomputedbasedon

marketpricesthatoccurduringthetradingperiod,excludingtradeoutliers.

Portfoliomanagersoftenspecifyanintradaybenchmarkforfundsthatare

tradingpassivelyovertheday,seekingliquidity,andforfundsthatmaybe

rebalancing,executingabuy/selltradelist,andminimizingrisk.Anintraday

pricebenchmarkisbasedonapricethatoccursduringthetradingperiod.The

mostcommonintradaybenchmarksusedintradingarevolume-weighted

averageprice(VWAP)andtime-weightedaverageprice(TWAP).Portfolio

managerschooseTWAPwhentheywishtoexcludepotentialtradeoutliers.

B.aTWAPparticipationstrategy.

C.aVWAPparticipationstrategy.

Case:RobertHarding

?Solution:A.

Giventhetradeurgencyoftheorder,theveryliquidmarketforABC

shares,andthesmallordersizerelativetoABC’sexpectedvolume,

Yellowisusinganarrivalpricetradingstrategythatwouldattemptto

executetheremainingsharesclosetomarketpricesatthetimethe

orderisreceived.

Case:RobertHarding

?WhattypeofalgorithmshouldbeusedtopurchasetheXYZshares

givenHarding’spriorityinbuildingtheXYZpositionandhisbelief

aboutpotentialpricemovements?

A.Scheduledalgorithm

B.Arrivalpricealgorithm

C.Opportunisticalgorithm

?Solution:A.

XYZsharesarerelativelyliquid,andHardinghasprioritizedminimizingthe

trade’smarketimpacttoavoidconveyinginformationtomarketparticipants.

Hardingalsodoesnotexpectadversepricemovementsduringthetrade

horizon.Scheduledalgorithmsareappropriateforordersinwhichportfolio

managersortradersdonothaveexpectationsforadversepricemovement

duringthetradehorizon.Thesealgorithmsarealsousedbyportfoliomanagers

andtraderswhohavegreaterrisktoleranceforlongerexecutiontimeperiods

andaremoreconcernedwithminimizingmarketimpact.Scheduledalgorithms

areoftenappropriatewhentheordersizeisrelativelysmall(e.g.,nomorethan

5%–10%ofexpectedvolume),thesecurityisrelativelyliquid,ortheordersare

partofarisk-balancedbasketandtradingallordersatasimilarpacewill

maintaintheriskbalance.

Case:RobertHarding

?WhichofYellow’sstatementsregardingthetradeimplementationof

non-equityinvestmentsiscorrect?

A.OnlyStatement4

B.OnlyStatement5

C.BothStatement4andStatement5

Case:RobertHarding

?Solution:A.

Smallcurrencytradesareusuallyimplementedusingdirectmarket

access(DMA).Buy-sidetradersgenerallyuseDMAforexchange-

tradedderivatives,particularlyforsmallertrades.

?BasedonExhibit1,theexecutioncostforpurchasingthe90,000shares

Case:RobertHarding

?Solution:C.

Executioncostiscalculatedasthedifferencebetweenthecostofthereal

portfolioandthepaperportfolio.Itreflectstheexecutionprice(s)paidforthe

numberofsharesintheorderthatwereactuallyfilledorexecuted.The

executioncostiscalculatedas:

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Case:RobertHarding

?BasedonExhibit1,theopportunitycostforpurchasingthe90,000

sharesofBYYPis:

Opportunitycostisbasedonthenumberofsharesleftunexecutedin

theorderandreflectsthecostofnotbeingabletoexecuteallshares

atthedecisionprice.Theopportunitycostiscalculatedas:

?

?

Case:RobertHarding

?Thearrivalcostforpurchasingthe90,000sharesofBYYPis:

Case:RobertHarding

?Solution:B.

Thearrivalcostiscalculatedas:

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?

?????????????

?Asitrelatestothetradepolicydocument,ValleyRiseshouldimplement

A.thelistofeligiblebrokers.

Case:RobertHarding

?Solution:B.

Firmsshouldhaveapolicyinplaceforthetreatmentoftradeerrors.

Errorsfromtradingandanyresultinggains/lossesneedtobe

disclosedtoafirm’scompliancedepartmentanddocumentedina

tradeerrorlog.Thetradeerrorlogshouldincludeanyrelated

documentationandevidencethattradeerrorsareresolvedinaway

thatavoidsadverseimpacttotheclient.

Reading35

PortfolioPerformanceEvaluation

?AlexandraJones,asenioradviseratFederalistInvestors(FI),meetswith

ErinBragg,ajunioranalyst.Braggjustcompletedamonthly

performanceevaluationforanFIfixed-incomemanager.Bragg’sreport

addressesthethreeprimarycomponentsofperformanceevaluation:

measurement,attribution,andappraisal.JonesasksBraggtodescribe

aneffectiveattributionprocess.Braggrespondsasfollows:

Response1:Performanceattributiondrawsconclusionsregardingthe

qualityofaportfoliomanager’sinvestmentdecisions.

Response2:Performanceattributionshouldhelpexplainhow

performancewasachievedbybreakingapartthereturnorriskinto

differentexplanatorycomponents.

Case:AlexandraJones

?Braggnotesthatthefixed-incomeportfoliomanagerhasstrongviews

abouttheeffectsofmacroeconomicfactorsoncreditmarketsand

followsatop-downinvestmentprocess.

?JonesreviewsthemonthlyperformanceattributionandasksBragg

whetheranyrisk-adjustedhistoricalperformanceindicatorsare

available.Braggproducesthefollowingdata:

Case:AlexandraJones

Exhibit110-YearTrailingRisk-AdjustedPerformance

Averageannualreturn

Minimumacceptablereturn(MAR)

Sharperatio

Sortinoratio

0.87

Upsidecapture

0.66

A.OnlyResponse1

B.OnlyResponse2

Case:AlexandraJones

?Solution:B.

Performanceattributionhelpsexplainhowperformancewasachieved;

itbreaksapartthereturnorriskintodifferentexplanatorycomponents.

Effectiveperformanceattributionmustaccountforalloftheportfolio’s

returnorriskexposure,reflecttheinvestmentdecision-makingprocess,

quantifytheactivedecisionsoftheportfoliomanager,andprovidea

completeunderstandingoftheexcessreturn/riskoftheportfolio.

Case:AlexandraJones

?Themostappropriateriskattributionapproachforthefixed-income

manageristo:

A.decomposehistoricalreturnsintoatop-downfactorframework.

B.evaluatethemarginalcontributiontototalriskforeachposition.

C.attributetrackingrisktorelativeallocationandselectiondecisions.

Theportfolioismanagedagainstabenchmark,whichindicatesa

relative-risktypeofriskattributionanalysis.Foratop-down

investmentapproach,theanalysisshouldattributetrackingriskto

allocationandselectiondecisionsrelativetothebenchmark.

Case:AlexandraJones

?BasedonExhibit1,thetargetsemideviationfortheportfolioisclosest

to:

Case:AlexandraJones

?Solution:B.

Thetargetsemi-standarddeviationortargetsemideviationisthe

denominatoroftheSortinoratio.ThenumeratoroftheSortinoratiois

theaverageportfolioreturnminusthetargetrateofreturn(minimum

acceptablereturn,orMAR).

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SubstitutingthevaluesprovidedinExhibit3,thetargetsemideviation

isasfollows:

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B.positiveasymmetryofreturns.

C.thattheportfoliogenerateshigherreturnsthanthebenchmark

duringallmarketconditions.

Case:AlexandraJones

?Solution:B.

Theupside/downsidecapture,orsimplythecaptureratio(CR),isthe

upsidecaptureratiodividedbythedownsidecaptureratio.

(Upsidecapture)/(Downsidecapture)=0.66/0.50=1.32.

Acaptureratiogreaterthan1indicatespositiveasymmetryofreturns,

oraconvexreturnprofile.

Case:AlexandraJones

?ThemaximumdrawdownanddrawdowndurationinExhibit1indicate

that:

A.theportfoliorecoveredquicklyfromitsmaximumloss.

B.overthe10-yearperiod,theaveragemaximumlosswas–24.00%.

Maximumdrawdownisthecumulativepeak-to-troughlossduringa

continuousperiod.Drawdowndurationisthetotaltimefromthestart

ofthedrawdownuntilthecumulativedrawdownrecoverstozero,

whichcanbesegmentedintothedrawdownphase(starttotrough)

andtherecoveryphase(troughtozerocumulativereturn).The

maximumdrawdownwas–24.00%,withadrawdownperiodoffour

months.Giventhe10-yeartimeframe,theportfoliorecoveredquickly

fromitsmaximumloss.

Case:StephanieTolmach

?StephanieTolmachisaconsultanthiredtocreateaperformanceattribution

reportonthreefundsheldbyadefinedbenefitpensionplan(thePlan).

Fund1isadomesticequitystrategy,Fund2isaglobalequitystrategy,and

Fund3isadomesticfixed-incomestrategy.

?Tolmachusesthreeapproachestoattributionanalysis:thereturn-based,

holdings-based,andtransaction-basedapproaches.ThePlan’sinvestment

committeeasksTolmachto(1)applytheattributionmethodthatusesonly

eachfund’stotalportfolioreturnsoverthelast12monthstoidentify

return-generatingcomponentsoftheinvestmentprocessand(2)include

theimpactofspecificactiveinvestmentdecisionsandtheattribution

effectsofallocationandsecurityselectioninthereport.

Case:StephanieTolmach

?TolmachfirstevaluatestheperformanceofFund1byconstructinga

FactorSensitivity

ContributiontoActiveReturn

FactorPortfolioBenchmarkDifferenceFactorReturn

Absolute

(3)h(4)

5.06%

0.29%

2.02%

–0.41%

6.96%

–10.95%

–3.99%

*

(2)

A.FactorTiltReturn:

B.SecuritySelection:

C.ActiveReturn(A+B):

*RMRFisthereturnonavalue-weightedequityindexinexcessoftheone-monthT-billrate,SMBis

thesmallminusbigmarketcapitalizationfactor,HMListhehighminuslowfactor,andWMListhe

winnersminuslosersfactor.

?TolmachturnsherattentiontoFund2,constructingaregion-based

microattributionanalysistoevaluatetheactivedecisionsofthe

portfoliomanager.TheresultsarepresentedinExhibit2.

Exhibit2Fund2Performance—AllocationbyRegion

PortfolioBenchmark

GreaterEurope

42.35%

23.16%

25.43%

Developed

Australasia

SouthAmerica

Total

Asia

and

29.86%

31.16%

11.33%

12.85%

20.38%

100.00%

18.82%

100.00%

20.00%

18.26%

35.26%

22.67%

Case:StephanieTolmach

?Next,TolmachevaluatesFund3andtheappropriatenessofits

benchmark.Thebenchmarkisacap-weightedbondindexwithdaily

reportedperformance;theindexisrebalancedfrequently,makingit

difficulttoreplicate.Thebenchmarkhasameaningfulinvestmentin

foreignbonds,whereasFund3investsonlyindomesticbonds.

?Inthefinalsectionofthereport,TolmachreviewstheentirePlan’s

characteristics,assetallocation,andbenchmark.Tolmachobservesthat

thePlan’sbenefitsarenolongerindexedtoinflationandthatthe

workforceis,onaverage,youngerthanitwaswhenthecurrentfund

allocationswereapproved.Tolmachrecommendsachangeinthe

Plan’sassetallocationpolicy.

Case:StephanieTolmach

?OfthethreeattributionapproachesreferencedbyTolmach,the

methodrequestedbythecommittee:

A.istheleastaccurate.

B.usestheunderlyingholdingsoftheactualportfolio.

C.isthemostdifficultandtimeconsumingtoimplement.

Thecommitteedescribedareturn-basedattribution,whichistheleast

accurateofthethreeapproaches(thereturn-based,holdings-based,

transaction-basedapproaches).Return-basedattributionusesonlythe

totalportfolioreturnsoveraperiodtoidentifythecomponentsofthe

investmentprocessthathavegeneratedthereturns.

Case:StephanieTolmach

?BasedonExhibit1andrelativetothebenchmark,themanagerofFund

1mostlikelyuseda:

A.growthtilt.

Case:StephanieTolmach

?Solution:A.

Basedonthefactorsensitivitiesincolumn1(negativesensitivityof–

0.17toHML)andthedifferencesrelativetothebenchmarkshownin

column3,themanagerlikelyhadagrowthtilt.

?BasedonExhibit1,whichofthefollowingfactorscontributedtheleast

Case:StephanieTolmach

?Solution:B.

Withanabsolutereturnof0.29%andwith7.33%ofthecontribution

toreturn,SMBcontributedfarlessthanHML(2.02%and50.53%,

respectively)andRMRF(5.06%and126.80%,respectively).

Case:StephanieTolmach

?BasedonExhibit1,themanagercouldhavedeliveredmorevalueto

theportfolioduringtheinvestmentperiodbyweightingmoretoward:

A.valuestocks.

B.small-capstocks.

C.momentumstocks.

Hadthemanagerweightedmoretowardmomentumstocksduring

theperiod,themomentumfactor(WML)returnof3.38%wouldhave

contributedpositivelytotheportfolio.

AisincorrectbecausetheHMLfactorreturnwas–9.60%;thus,

weightingmoretowardvaluestockswouldhavedetractedfrom

portfolioreturns.

BisincorrectbecausetheSMBfactorreturnwas–3.25%;thus,

weightingmoretowardsmall-capstockswouldhavedetractedfrom

portfolioreturns.

Case:StephanieTolmach

?BasedonExhibit2,theallocationeffectforSouthAmericaisclosestto:

Case:StephanieTolmach

?Solution:C.

TheallocationeffectforSouthAmericais0.20%.

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?

?

?

?BasedonExhibit2,thedecisiontooverweightorunderweightwhichof

thefollowingregionscontributedpositivelytoperformanceatthe

overallfundlevel?

A.NorthAmerica

C.DevelopedAsiaandAustralasia

Case:StephanieTolmach

?Solution:C.

ThedecisiontounderweightdevelopedAsiaandAustralasiawasa

goodonebecausethebenchmarkforthisregionunderperformedthe

totalbenchmark(12.85%versus22.67%).Alternatively,thequestion

canbeansweredbycalculatingtheallocationeffectsforthethree

regions,asfollows:

Case:StephanieTolmach

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?

?

?

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??????Ψ

DevelopedAsiaandAustralasiaistheonlyregionofthethreethathad

apositiveallocationeffect.

?BasedonExhibit2,theunderperformanceattheoverallfundlevelis

predominantlytheresultofpoorsecurityselectiondecisionsin:

A.SouthAmerica.

B.greaterEurope.

C.developedAsiaandAustralasia.

Case:StephanieTolmach

?Solution:A.

Thetotal–441bpsofunderperformancefromsecurityselectionand

interactionattheoverallfundlevelispredominantlytheresultofpoor

SouthAmericansecurityselectiondecisions(–311bps=3.11%).

ReturnAttribution

(SegmentLevel)

NorthAmerica

GreaterEurope

DevelopedAsiaandAustralasia

SouthAmerica

Allocation

Total

Total

Case:StephanieTolmach

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?

?

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Selection+Interaction=WiR–B+w–WR–B

i

i

i

i

i

i

NorthAmerica=7.67%(16.50%–16.47%)+(10.84%–7.67%)(16.50%–16.47%)

=0.00%

GreaterEurope=42.35%(23.16%–25.43%)+(38.92%–42.35%)(23.16%–

25.43%)

=–0.88%

DevelopedAsiaandAustralasia=31.16%(11.33%–12.85%)+(29.86%–

31.16%)(11.33%–12.85%)

=–0.45%

SouthAmerica=18.82%(20.00%–35.26%)+(20.38%–18.82%)(20.00%–

35.26%)

=–3.11%

Case:StephanieTolmach

?ThebenchmarkforFund3haswhichofthefollowingcharacteristicsof

avalidbenchmark?

Case:StephanieTolmach

?Solution:B.

Dailyreportedperformanceisavailableforthebenchmark;thus,itispossible

tomeasurethebenchmark’sreturnonareasonablyfrequentandtimelybasis.

Aisincorrectbecausethebenchmarkisacap-weightedbondindexthatis

rebalancedfrequently,makingitdifficulttoreplicate.Forabenchmarktobe

investable,itmustbepossibletoreplicateandholdthebenchmarktoearnits

return(atleastgrossofexpenses).Thesponsorshouldhavetheoptionof

movingassetsfromactivemanagementtoapassivebenchmark.Ifthe

benchmarkisnotinvestable,itisnotaviableinvestmentalternative.Bond

indexesareoftennotinvestableandarerebalancedfrequentlyovertime.

Cisincorrectbecausetheindexhasameaningfulinvestmentinforeignbonds,

whereasFund3investsonlyindomesticbonds,makingthebenchmark

inappropriate.Thebenchmarkmustbeconsistentwiththemanager’s

investmentstyleorareaofexpertise.

Case:StephanieTolmach

?BasedonthefinalsectionofTolmach’sreport,thePlanshoulduse:

A.aliability-basedbenchmark.

B.anabsolutereturnbenchmark.

C.amanageruniversebenchmark.

Case:StephanieTolmach

?Solution:A.

BasedonthePlan’stype(definedbenefit)anditscharacteristicsas

detailedinthefinalsectionofTolmach’sreport,aliability-based

benchmarkismostappropriate.Liability-basedbenchmarksareused

mostfrequentlywhenassetsarerequiredtopayaspecificfuture

liability,asinadefinedbenefitpensionplan.

InvestmentManagerSelection

Case:TreeFallersEndowment

?TheTreeFallersEndowmentplanstoallocatepartofitsportfolioto

alternativeinvestmentfunds.TheendowmenthashiredKurtSummer,a

consultantatSummerBrothersConsultants,toidentifysuitable

alternativeinvestmentfundsforitsportfolio.

?Summerhasidentifiedthreefundsforpotentialinvestmentandwill

presenttheperformanceoftheseinvestmentstotheendowment’s

boardofdirectorsattheirnextquarterlymeeting.

?Summerisreviewingeachofthefund’sfeeschedulesandisconcerned

aboutthemanager’sincentivetotakeonexcessriskinanattemptto

generateahigherfee.Exhibit1presentsthefeeschedulesofthethree

funds.

Case:TreeFallersEndowment

Exhibit1FeeSchedules

Maximum

AnnualFee

Fund

ComputedFee

Sharing

Higherofeither(1)baseor(2)baseplus

sharingofpositiveperformance;sharingis1.00%

basedonreturnnetofthebasefee.

20%

na

2.50%

na

Higherofeither(1)baseor(2)baseplus

BlueWatersharingofpositiveperformance,uptoa

0.50%

Fund

maximumannualfeeof2.50%;sharingis

basedonactivereturn.

?Exhibit2presentstheannualgrossreturnsforeachfundandits

respectivebenchmarkfortheperiodof2016–2018.Allfundshavean

inceptiondateof1January2016.Summerintendstoincludeinhis

reportanexplanationoftheimpactofthefeestructuresofthethree

fundsonreturns.

Case:TreeFallersEndowment

Exhibit2FundandBenchmarkReturns

Year

2016

2017

2018

Benchmark

Benchmark

Benchmark

Fund

Red

Grass

Fund

Blue

Water

Fund

Yellow

Wood

Fund

8.00

10.00

15.00

8.00

–2.00

–4.00

–5.00

–10.00

–1.50

–6.50

5.00

14.00

7.00

4.50

2.00

9.50

9.00

14.00

Case:TreeFallersEndowment

?TheboardofdirectorsoftheTreeFallersEndowmentasksSummerto

recalculatethefeesoftheRedGrassFundassumingahigh-watermark

featurewherebyasharingpercentagecouldonlybechargedtothe

extentanylosseshadbeenrecouped.

?BasedonExhibit1,whichfundhasasymmetricalfeestructure?

Case:TreeFallersEndowment

?Solution:C.

Asymmetricalfeestructureisoneinwhichthefeesareaffectedby

bothpositiveandnegativeperformance.OfthethreefundsinExhibit

1,onlyYellowWoodhasasymmetricalstructure.YellowWood’sprofit

sharingcomponentwillbenegativeifitsreturnisnegativeand

positiveifitispositive.

Case:TreeFallersEndowment

?BasedonthefeeschedulesinExhibit1,theportfoliomanagerofwhich

fundhasthegreatestincentivetoassumeadditionalrisktoearna

higherinvestmentmanagementfee?

A.RedGrass

RedGrass’sfeearrangementallowsforunlimitedperformance-based

feesontheupsideandnonegativeconsequencesonthedownside.

Case:TreeFallersEndowment

?BasedonExhibit1andExhibit2,theYellowWoodFund’s2016

investmentmanagement