Skip to content

FRM Part II · FRM Exam Part II · Portfolio Performance Evaluation

A risk manager wants to estimate ex-ante tracking error for an equity fund. Which approach is most appropriate for a portfolio whose active positions have changed substantially over the past year?

Use the current active weights with a covariance matrix of asset returns. This gives forward-looking ex-ante tracking error that reflects today's positions, whereas the historical standard deviation of realized active returns reflects old holdings that have since changed.

  1. ACompute the standard deviation of the past year of realized active returns
  2. BUse current active weights with a covariance matrix of asset returns to compute the standard deviation of the active portfolioCorrect
  3. CUse the portfolio's Sharpe ratio divided by that of the benchmark
  4. DUse the portfolio's beta times market volatility

Explanation

Ex-ante tracking error is forward-looking and based on current holdings: active weights combined with a covariance matrix. Realized (ex-post) tracking error reflects past positions that no longer apply, so it misestimates current risk. Sharpe ratio and beta do not measure benchmark-relative risk.

Did you get it right without looking?

One question tells you little. A timed set on Portfolio Performance Evaluation shows your real accuracy, how long you take and where you lose marks.

Practise Portfolio Performance EvaluationFree diagnostic mock

More Portfolio Performance Evaluation questions