Justification this strategy would mitigate manager as

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Justification: This strategy would mitigate Manager A’s weakness by hedging all currency exposures into index-like weights. This would allow capture of Manager A’s country and stock selection skills while avoiding losses from poor currency management. This strategy would also mitigate Manager B’s weakness, leaving an index-like portfolio construct and capitalizing on the apparent skill in currency management. 2. Recommendation: Another strategy would be to combine the portfolios of Manager A and Manager B, with Manager A making country exposure and security selection decisions and Manager B managing the currency exposures created by Manager A’s decisions (providing a “currency overlay”). Justification: This recommendation would capture the strengths of both Manager A and Manager B and would minimize their collective weaknesses. 13. a. Indeed, the one year results were terrible, but one year is a poor statistical base from which to draw inferences. Moreover, the board of trustees had directed Karl to adopt a long-term horizon. The Board specifically instructed the investment manager to give priority to long term results. b. The sample of pension funds had a much larger share invested in equities than did Alpine. Equities performed much better than bonds. Yet the trustees told Alpine to hold down risk, investing not more than 25% of the plan’s assets in common stocks. (Alpine’s beta was also somewhat defensive.) Alpine should not be held responsible for an asset allocation policy dictated by the client. c. Alpine’s alpha measures its risk-adjusted performance compared to the market: α = 13.3% – [7.5% + 0.90(13.8% – 7.5%)] = 0.13% (actually above zero) d. Note that the last 5 years, and particularly the most recent year, have been bad for bonds, the asset class that Alpine had been encouraged to hold. Within this asset class, however, Alpine did much better than the index fund. Moreover, despite the fact that the bond index underperformed both the actuarial return and T-bills, Alpine outperformed both. Alpine’s performance within each asset class has been superior on a risk-adjusted basis. Its overall disappointing returns were due to a heavy asset allocation weighting towards bonds, which was the Board’s, not Alpine’s, choice. 24-7
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e. A trustee may not care about the time-weighted return, but that return is more indicative of the manager’s performance. After all, the manager has no control over the cash inflows and outflows of the fund. 14. a. Method I does nothing to separately identify the effects of market timing and security selection decisions. It also uses a questionable “neutral position,” the composition of the portfolio at the beginning of the year. b. Method II is not perfect, but is the best of the three techniques. It at least attempts to focus on market timing by examining the returns for portfolios constructed from bond market indexes using actual weights in various indexes versus year-average weights. The problem with this method is that the year- average weights need not correspond to a client’s “neutral” weights.
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