CFA Level I · CFA Level I Exam · Benchmarking Returns
A portfolio manager's mandate is small-cap value equities, but performance is measured against a broad large-cap index. The most likely consequence for performance evaluation is that the:
The manager's active return will mostly reflect style and size differences rather than skill. A large-cap index does not match a small-cap value mandate, so it is not appropriate, and the measured excess return is contaminated by systematic exposure differences.
- Amanager's active return mostly reflects style differences, not skillCorrect
- Bbenchmark becomes easier to replicate with index funds
- Ctracking error is guaranteed to fall to zero
Explanation
An inappropriate benchmark does not match the manager's style or mandate. Excess returns then capture the size and value exposure mismatch instead of security selection skill. Tracking error would typically rise, not fall, and the benchmark's replicability is irrelevant to this problem.
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