Question

Use the following information to answer Problems l2–16:

Primo Management Co. is looking at how best to evaluate the performance of its managers. Primo has been hearing more and more about benchmark portfolios and is interested in trying this approach. As such, the company hired Sally Jones, CFA, as a consultant to educate the managers on thebest methods for constructing a benchmark portfolio, how best to choose a benchmark, whether the style of the fund under management matters, and what they should do with their global funds in terms of benchmarking.

For the sake of discussion, Jones put together some comparative two-year performance numbers that relate to Primo’s current domestic funds under management and a potential benchmark.

As part of her analysis, Jones also takes a look at one of Primo’s global funds. In this particular portfolio, Primo is invested 75% in Dutch stocks and 25% in British stocks.

The benchmark invested 50% in each—Dutch and British stocks. On average, the British stocks outperformed the Dutch stocks. The euro appreciated 6% versus the U.S. dollar over the holding period, while the pound depreciated 2% versus the dollar. In terms of the local return, Primo outperformed the benchmark with the Dutch investments but underperformed the index with respect to the British stocks.

Question: What is the within-sector selection effect for each individual sector?

Short answer

Large cap growth: 0.6%

Mid-cap growth: -0.3%

Small-cap growth: 0.5%

Step-by-step solution

Definition of within sector selection

The within-sector selection calculates the return following security selection. This is calculated by summing up the weight of security in the portfolio multiplied by return of the security in the portfolio minus the return of security in the benchmark.

Calculation of Selection effect

Selection effect = (Portfolio return – Bogey return) x Portfolio weight

Large cap growth: (.17 -.16) x 0.6 = .006 = 0.6%

Mid-cap growth: (.24 - .26) x 0.15 = -.003 = -0.3%

Small-cap growth: (.20 - .18) x 0.25 = .005 = 0.5%

Total effect = .006 + (-.003) + .005 = .008 = 0.8%