Study guide

12.3 Performance Measures & Reporting

Series 65 Uniform Investment Adviser Law

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1 Introduction

About the Series 65 How to Use This Guide

2 Chapter 1: Economic Factors & Business Cycles

1.1 Business Cycles 1.2 Monetary Policy 1.3 Fiscal Policy 1.4 Inflation & Deflation 1.5 Interest Rates & Yield Curves 1.6 Global Economic Factors

3 Chapter 2: Financial Reporting & Analytical Methods

2.1 Financial Statements Overview 2.2 Accounting Fundamentals 2.3 SEC Filings & Annual Reports 2.4 Financial Ratios 2.5 Time Value of Money 2.6 IRR and NPV 2.7 Descriptive Statistics

4 Chapter 3: Types of Risk

3.1 Systematic (Market) Risk 3.2 Unsystematic (Company-Specific) Risk 3.3 Interest Rate & Reinvestment Risk 3.4 Inflation & Currency Risk 3.5 Liquidity Risk & Opportunity Cost 3.6 Risk Measurement & Portfolio Theory

5 Chapter 4: Cash Equivalents & Fixed Income Securities

4.1 Cash & Cash Equivalents 4.2 Treasury Securities 4.3 Agency Securities 4.4 Corporate Bonds 4.5 Municipal Bonds 4.6 Bond Pricing & Yields

6 Chapter 5: Equity Securities

5.1 Common Stock 5.2 Preferred Stock 5.3 Shareholder Rights & Corporate Actions 5.4 Equity Valuation Methods 5.5 ADRs, REITs & Other Equity Securities

7 Chapter 6: Pooled Investments

6.1 Mutual Funds 6.2 Mutual Fund Costs & Fees 6.3 Exchange-Traded Funds (ETFs) 6.4 Closed-End Funds & UITs 6.5 Hedge Funds & Private Equity

8 Chapter 7: Derivatives, Alternative Investments & Insurance Products

7.1 Options Basics 7.2 Options Strategies 7.3 Alternative Investments 7.4 Annuities 7.5 Life Insurance Products

9 Chapter 8: Client Types & Profiles

8.1 Individual Clients 8.2 Business Entity Clients 8.3 Trusts & Estates 8.4 Accredited & Qualified Investors 8.5 Suitability & Know Your Customer

10 Chapter 9: Portfolio Theory & Capital Markets

9.1 Modern Portfolio Theory 9.2 Capital Asset Pricing Model (CAPM) 9.3 Efficient Market Hypothesis 9.4 Risk & Performance Measures 9.5 Asset Allocation

11 Chapter 10: Portfolio Management Strategies

10.1 Investment Styles 10.2 Portfolio Management Techniques 10.3 Fixed Income Strategies 10.4 Return Calculations

12 Chapter 11: Tax Considerations & Retirement Planning

11.1 Capital Gains & Investment Taxes 11.2 Retirement Plans Overview 11.3 Individual Retirement Accounts (IRAs) 11.4 Education Savings Plans 11.5 Distributions & RMDs

13 Chapter 12: ERISA, Special Accounts & Performance Measures

12.1 ERISA Requirements 12.2 Special Account Types 12.3 Performance Measures & Reporting 12.4 QDROs & Special Situations

14 Chapter 13: Regulation of Investment Advisers

13.1 Investment Advisers Act of 1940 13.2 Registration Requirements 13.3 Recordkeeping Requirements 13.4 Custody Requirements 13.5 Exempt Reporting Advisers

15 Chapter 14: Regulation of Investment Adviser Representatives

14.1 IAR Definition & Requirements 14.2 Registration & Post-Registration 14.3 IARs of Federal Covered Advisers

16 Chapter 15: Regulation of Broker-Dealers & Agents

15.1 Broker-Dealer Definition 15.2 Agent Registration 15.3 Regulation Best Interest

17 Chapter 16: Securities Registration & Exemptions

16.1 Uniform Securities Act 16.2 Securities Registration Methods 16.3 Exempt Securities 16.4 Exempt Transactions

18 Chapter 17: Communications & Client Relationships

17.1 Advertising Rules 17.2 Social Media & Electronic Communications 17.3 Client Agreements & Disclosure 17.4 Proxy Voting & Other Obligations

19 Chapter 18: Ethics & Fiduciary Obligations

18.1 Fiduciary Duties 18.2 Prohibited Practices 18.3 Senior & Vulnerable Adult Protection 18.4 AML & Compliance Programs

12.3 Performance Measures & Reporting

Key Takeaways Explain This Topic AI

TWR measures manager performance; MWR measures investor experience.

Sharpe uses total risk; Treynor uses systematic risk.

Positive Jensen's alpha indicates outperformance versus CAPM.

GIPS standards are voluntary and require TWR.

All discretionary, fee-paying accounts must be in composites.

Benchmarks must be investable, measurable, and set in advance.

Last updated: December 2025

Accurate performance measurement is essential for evaluating investment results and comparing managers. Understanding various performance metrics and reporting standards is critical for investment advisers.

  • Return Calculations
  • Total Return

Total return captures all sources of investment gain: Total Return = Ending Value − Beginning Value + Income Beginning Value \text{Total Return} = \frac{\text{Ending Value} - \text{Beginning Value} + \text{Income}}{\text{Beginning Value}} Total Return = Beginning Value Ending Value − Beginning Value + Income ​

Example: An investment of $10,000 grows to $11,000 and pays $200 in dividends:

  • Total Return = ($11,000 - $10,000 + $200) / $10,000 = 12%
  • Annualized Return

Converts returns to an annual equivalent for comparison: Annualized Return = ( 1 + Total Return ) 1 Years − 1 \text{Annualized Return} = (1 + \text{Total Return})^{\frac{1}{\text{Years}}} - 1 Annualized Return = ( 1 + Total Return ) Years 1 ​ − 1

Example: A 33.1% return over 3 years:

  • Annualized = (1.331)^(1/3) - 1 = 10% per year
  • Time-Weighted Return (TWR)

TWR eliminates the impact of cash flows to measure pure investment performance:

  • Characteristic Description
  • Purpose Measure manager skill
  • Cash Flows Eliminates their effect
  • GIPS Required Yes
  • Best For Comparing managers
  • How It Works: Links sub-period returns before and after each cash flow
  • Money-Weighted Return (MWR / IRR)

MWR reflects the investor's actual experience, including the timing of cash flows:

  • Characteristic Description
  • Purpose Measure investor's actual return
  • Cash Flows Reflects their timing
  • Best For Personal performance assessment
  • Calculation Internal rate of return (IRR)

On the Exam: TWR is for comparing managers (GIPS requirement). MWR shows the investor's actual experience and is affected by the timing of their contributions and withdrawals.

  • Risk-Adjusted Performance Measures
  • Sharpe Ratio

Measures excess return per unit of total risk (standard deviation): Sharpe Ratio = Portfolio Return − Risk-Free Rate Standard Deviation \text{Sharpe Ratio} = \frac{\text{Portfolio Return} - \text{Risk-Free Rate}}{\text{Standard Deviation}} Sharpe Ratio = Standard Deviation Portfolio Return − Risk-Free Rate ​

  • Feature Description
  • Risk Measure Standard deviation (total risk)
  • Interpretation Higher is better
  • Best For Undiversified portfolios or sole investments
  • Limitation Penalizes both upside and downside volatility
  • Treynor Ratio

Measures excess return per unit of systematic risk (beta): Treynor Ratio = (Portfolio Return - Risk-Free Rate) / Beta

  • Feature Description
  • Risk Measure Beta (systematic risk only)
  • Interpretation Higher is better
  • Best For Well-diversified portfolios
  • Assumption Unsystematic risk has been diversified away
  • Jensen's Alpha

Measures the excess return above what CAPM predicts: Alpha = Actual Return - [Risk-Free Rate + Beta × (Market Return - Risk-Free Rate)]

  • Alpha Value Interpretation
  • Positive Outperformed risk-adjusted expectation
  • Zero Performed as expected
  • Negative Underperformed risk-adjusted expectation
  • Example: If CAPM predicts a 10% return but the portfolio earned 12%, alpha = 2%
  • Information Ratio

Measures the consistency of outperformance relative to a benchmark: Information Ratio = Active Return / Tracking Error

Where:

  • Active Return = Portfolio Return - Benchmark Return
  • Tracking Error = Standard deviation of active returns
  • Information Ratio Interpretation
  • 0.5+ Good
  • 0.75+ Very Good
  • 1.0+ Excellent
  • Comparison of Measures
  • Measure Risk Basis Best Use
  • Sharpe Ratio Total risk (std dev) Single portfolio evaluation
  • Treynor Ratio Systematic risk (beta) Diversified portfolios
  • Jensen's Alpha Systematic risk (beta) Manager skill assessment
  • Information Ratio Tracking error Active manager consistency
  • Benchmarking
  • Benchmark Selection Criteria

An appropriate benchmark should be:

  • Criterion Description
  • Investable Could actually be purchased
  • Measurable Returns can be calculated
  • Appropriate Reflects strategy and style
  • Unambiguous Clearly defined constituents
  • Specified in Advance Known before the period
  • Owned Manager accepts it as valid comparison
  • Common Benchmarks
  • Asset Class Common Benchmark
  • U.S. Large Cap S&P 500
  • U.S. Small Cap Russell 2000
  • U.S. Aggregate Bonds Bloomberg U.S. Aggregate
  • International Developed MSCI EAFE
  • Emerging Markets MSCI Emerging Markets
  • Real Estate NCREIF, FTSE NAREIT
  • Global Investment Performance Standards (GIPS)

GIPS are voluntary ethical standards for investment performance presentation, created by CFA Institute.

  • Objectives of GIPS
  • Promote investor confidence
  • Ensure accurate and consistent performance data
  • Establish a global standard for comparison
  • Promote fair competition among firms
  • Encourage industry self-regulation
  • Who Can Claim GIPS Compliance
  • Can Claim Cannot Claim
  • Investment management firms Individual advisers
  • Asset owners managing discretionary assets Brokers without discretion
  • Firms competing for business Non-investment firms
  • Key GIPS Requirements
  • Requirement Details
  • Minimum Performance History At least 5 years (building to 10)
  • Return Calculation Time-weighted returns required
  • Composite Construction All discretionary, fee-paying accounts
  • Fee Disclosure Both gross and net-of-fee returns
  • Verification Voluntary but recommended
  • GIPS Composite Requirements

All fee-paying discretionary portfolios must be included in at least one composite based on:

  • Similar investment strategy
  • Similar risk/return objectives
  • Comparable mandates

On the Exam: GIPS is voluntary, requires time-weighted returns, and all discretionary fee-paying accounts must be in composites. No "cherry-picking" of best performers.

  • Key Takeaways
  • TWR measures manager performance (GIPS required); MWR measures investor experience
  • Sharpe uses total risk (std dev); Treynor uses systematic risk (beta)
  • Positive Jensen's alpha means outperformance vs. CAPM prediction
  • GIPS are voluntary standards requiring TWR and composite presentation
  • Benchmarks must be investable, measurable, appropriate, and specified in advance

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