Question

Use the following information to answer Problems l2–16:

Primo Management Co. islooking at how best to evaluate the performance of its managers. Primo has been hearingmore and more about benchmark portfolios and is interested in trying this approach. Assuch, the company hired Sally Jones, CFA, as a consultant to educate the managers on the

best 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 withtheir global funds in terms of benchmarking.

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

As part of her analysis, Jones also takes a look at one of Primo’s global funds. In thisparticular 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 Britishstocks outperformed the Dutch stocks. The euro appreciated 6% versus the U.S. dollarover the holding period, while the pound depreciated 2% versus the dollar. In terms of thelocal return, Primo outperformed the benchmark with the Dutch investments but underperformedthe index with respect to the British stocks.

Question: Which of the following statements about Primo’s global fund is most correct?

Primoappears to have a positive currency allocation effect as well as:

a. A negative market allocation effect and a positive security allocation effect.

b. A negative market allocation effect and a negative security allocation effect.

c. A positive market allocation effect and a negative security allocation effect.

Short answer

Option A

Step-by-step solution

Definition of allocation effect 

The aim to place a higher weight on sectors that perform well is known as allocation effect.

Explanation on Primo’s global fund

Owing to the greater stake of Primo in euro dominated assets (when euro appreciated while pound depreciated), the positive currency effect took place. On the other hand, British stocks outperformed Dutch stocks hence a negative market allocation effect happened for Primo. Finally Primo also outperformed with Dutch investment and underperformed with British investments,

Since Primo had greater stakes with Dutch investment, it is likely to have a positive security effect in total.

Hence the correct option is option A.

Incorrect options explanation

b. The overall security will improve as Primo has larger holdings with Dutch investment and will not experience a decreased effect. Hence, option b is incorrect.

c. Since the British stock outperformed Dutch stock, negative market has occurred and not a positive market. So, option c is incorrect.