According to Co-readings, skill of portfolio manager is captured by Information Coefficient(IC). Is answer of this question correct ?
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Your concern is valid, and it highlights a potential ambiguity or complexity in the question. The Information Ratio (IR) is indeed a risk-adjusted relative performance metric, and it incorporates both the Information Coefficient (IC) and the number of independent bets (BR). While a higher IR can suggest better risk-adjusted performance, it may not necessarily reflect superior skill in forecasting.
Your point about managers increasing the number of bets to boost IR is valid. If a manager takes more bets, it might increase the numerator (IC * √BR), potentially leading to a higher IR. However, the increased number of bets (BR) may not necessarily indicate improved skill but rather a different approach to managing the portfolio.
The challenge here lies in the fact that the Information Ratio, being a composite metric, makes it challenging to isolate the contribution of the Information Coefficient alone to the skill assessment.
In the real world, the evaluation of a portfolio manager’s skill is a nuanced process that involves considering various factors beyond a single metric. It may involve a combination of quantitative metrics, qualitative assessments, and a deep understanding of the manager’s investment process.
As for the question’s relevance to an exam, it depends on the learning objectives and the focus of the curriculum. If the curriculum emphasizes a nuanced understanding of performance metrics and their limitations, the question may be relevant for testing your ability to critically analyze and apply these concepts. However, if the question creates confusion due to potential contradictions, it might be worth seeking clarification or discussing it with your instructor or peers. Exam questions should ideally be clear and unambiguous to effectively assess the knowledge and understanding of the candidates.
The solution provided in the question focuses on the Information Ratio (IR) as the key metric for evaluating the skill of the portfolio managers. The Information Ratio measures the consistency of active return generation on a risk-adjusted basis.
However, the Information Coefficient (IC) is also mentioned in the exhibit data, and it is indeed another important metric in evaluating the skill of a portfolio manager. The Information Coefficient measures the manager’s ability to generate forecasts that are accurate and informative.
In the context of the question, if you want to consider the Information Coefficient as an indicator of skill, you may want to compare the IC values for each candidate. The higher the Information Coefficient, the better the manager’s ability to generate accurate and informative forecasts.
Let’s compare the IC values for each candidate:
In this case, Candidate A has the highest Information Coefficient (0.832), followed by Candidate C (0.548), and Candidate B has the lowest (0.07). Therefore, based on the Information Coefficient, Candidate A appears to have the greatest skill.
The solution provided in the question focuses on the Information Ratio (IR) as the primary metric for evaluating the skill of the portfolio managers. According to the explanation, Candidate B has the highest Information Ratio (IR) of 0.746, which indicates better managerial skill at achieving active returns on a risk-adjusted basis.
I get you. But I think IR shouldn’t be counted as managerial skills because it is just risk-adjusted relative performance metric.
IR is calculated as : IC(BR)^0.5, where IC represents managerial skills and BR is the number of independent bets of extraordinary returns.
If manager just increase the number of bets IR will rise without considering skills. But, even if we consider that BR is also the part of skill set, then my concern is that should I consider this question as exam relevant or not? CFAI institute shouldn’t have given the contradicting figures and options.
I THINK THE DOUBT CAN BE SIMPLIFIED,
IR IS THE ABILITY OF THE PORTFOLIO MANAGER TO GENERATE THE ACTIVE RETURN CONSISTENTLY, WHEREAS IC IS THE SKILL OF THE MANAGER TO FORECAST CORRECTLY.
THE QUESTION WANTS US TO LIST OUT THE MANAGER HAVING A SKILL SET TO GENERATE ACTIVE RETURN WHICH INDICATES TOWARDS THE IR AND NOT IC.
HOPE THIS HELPS