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Free CFA Performance Measurement Practice Questions & Answers
300 exam-style Performance Measurement questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 151
What are the FOUR Ps of qualitative manager due diligence, and what does each evaluate?
Select an option first.
Correct answer: B — Philosophy (what market inefficiency does the manager seek to exploit, and is the belief in that inefficiency internally consistent?), Process (is the investment process capable of exploiting the inefficiency in a repeatable way?), People (do the team members have the knowledge and skills to execute the process consistently?), Portfolio (is the actual portfolio construction congruent with the philosophy and process?). All four must align for returns to be repeatable.
Explanation: B is correct: The reading explicitly names the four Ps as the framework for assessing continuity of returns. Philosophy: if a manager claims to exploit momentum inefficiencies but their trades show no momentum signal, the philosophy is inconsistent. Process: if the process involves discretionary overrides of a quantitative model, repeatability is lower. People: high staff turnover destroys process knowledge regardless of how good the documented process is. Portfolio: if the portfolio holds large positions inconsistent with the stated philosophy (e.g., a deep-value manager owning high-multiple growth stocks), either the philosophy is wrong or the portfolio is wrong—alignment is essential.
Question 152
What LIQUIDITY STRUCTURE has the LOWEST liquidity for investors among closed-end funds, open-end funds, ETFs, hedge funds, and private equity funds?
Select an option first.
Correct answer: B — Private equity and venture capital funds — investors face capital calls (cash is deployed gradually) and typically receive no returns for the first ~5 years of the fund's 10-year life. The manager may extend the fund life by up to two one-year periods, further reducing liquidity. Hedge funds have lockup periods and gates but typically have more frequent redemption windows than PE.
Explanation: B is correct: The reading ranks liquidity from highest to lowest: ETFs and closed-end funds (intraday trading) > open-end funds (daily NAV redemption) > hedge funds (monthly/quarterly redemptions with lockups/gates) > private equity/venture capital (lowest—capital calls, 5–10+ year lock-up, no secondary market for most positions). PE and VC are ranked lowest because investors commit capital that is called over years, earn no distributions until portfolio companies are exited (typically 5–7 years in), and have very limited secondary market options. The manager can also extend the fund life, adding further uncertainty about when liquidity occurs.
Question 153
Under what THREE conditions can a new firm link its performance history to a previous firm under GIPS portability rules?
Select an option first.
Correct answer: B — All four GIPS portability conditions must be met for linked performance: (1) Substantially all investment decision-makers are retained; (2) The decision-making process remains substantially intact and independent; (3) The new firm has records documenting previous performance; (4) There is no break in the performance record. If only the first three conditions are met (e.g., there was a garden leave causing a break), the prior history can be referenced but cannot be linked in the performance presentation.
Explanation: B is correct: The four-condition portability test ensures that linked historical performance genuinely reflects the same investment process and people. If the star portfolio manager left the old firm and started a new one, taking the performance record without taking substantially all the decision-makers would be misleading—the record reflects a team that no longer exists. The break-in-record condition (condition 4) prevents gaps: if employees took a garden leave (temporary leave at acquisition), no performance was generated during that period, creating a break that prohibits full linkage (though the prior record can still be disclosed separately). Note: the question says 'THREE conditions' but GIPS actually requires FOUR—the correct answer (B) accurately lists all four.
Question 154
What role does the BENCHMARK play at the manager universe stage, before any performance assessment occurs?
Select an option first.
Correct answer: B — The benchmark defines the role the manager will play within the portfolio and anchors the style classification process. It is determined using one or more of: third-party categorization databases, returns-based style analysis, holdings-based style analysis, and manager experience (examination of past holdings and returns). The benchmark ensures candidates in the universe genuinely match the style exposure the investor is seeking.
Explanation: B is correct: The reading states 'the search usually begins by establishing the role for the potential manager within the portfolio and that is defined by the benchmark.' Without a clear benchmark reference point, the manager universe would be based on subjective style labels that may not align with the investor's actual portfolio needs. A pension fund seeking to add a UK mid-cap exposure needs a benchmark (e.g., FTSE 250) to define the universe—not all managers who call themselves 'UK equity' are appropriate candidates. The benchmark provides an objective filter before any performance data is examined.
Question 155
What four characteristics of INFORMATION give an investment manager an informational advantage in idea generation?
Select an option first.
Correct answer: B — The information must be: (1) Unique—provides an edge not available to all market participants; (2) Timely—obtained and acted upon quickly before others can exploit the same information; (3) Interpretable—the manager has superior cognitive or analytical skills to extract more insight from the information than competitors; and (4) Actionable—the information must translate into a profitable trade. All four must hold simultaneously for a genuine informational advantage.
Explanation: B is correct: The reading states that 'investment strategies must utilize unique information to have an informational advantage' AND that 'that information must be obtained and used on a very timely basis' AND that 'the investment manager must have superior cognitive or interpretive skills.' Consider a manager who reads the same earnings release as every other investor but processes it faster (timeliness) and draws more accurate implications (interpretability) about 18-month earnings trajectory. This edge is real if the information is processed uniquely and quickly. A manager with unique data but slow processing may be exploited by faster competitors who reach the same conclusion first.
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Question 156
What is SIGNAL CAPTURE in the investment decision-making process, and what are the two key concerns at this step?
Select an option first.
Correct answer: B — Signal capture (idea implementation) is the step where an investment idea (signal/inefficiency) is transformed into an actual investment position. Two key concerns: (1) Repeatability—can this signal-to-position conversion be executed consistently using the same process? Is the process well-documented and not dependent on a single individual? (2) Congruence—is the position being taken consistent with the investment philosophy? An identified value opportunity should result in a value position, not a momentum bet.
Explanation: B is correct: The investment decision-making process has four steps: Idea Generation → Idea Implementation (signal capture) → Portfolio Construction → Monitoring. Signal capture bridges the intellectual identification of an opportunity and the actual portfolio bet. The repeatability concern asks: can this work at scale and over time, not just once? The congruence concern asks: does the position match the stated philosophy? A manager claiming to run a mean-reversion strategy who takes momentum positions at the signal capture step is being inconsistent—suggesting either the philosophy description is wrong or the process is undisciplined.
Question 157
What does the reading mean by the manager being a NET SUPPLIER vs. NET DEMANDER of liquidity, and why does this matter?
Select an option first.
Correct answer: B — A net supplier of liquidity posts limit orders (provides immediacy to others), while a net demander crosses the spread with market orders (demands immediacy). A manager consistently demanding liquidity pays the bid-ask spread repeatedly, increasing transaction costs. Liquidity considerations in portfolio construction also include: what proportion of the portfolio can be liquidated within 5 days (high flexibility), and what proportion requires more than 10 days (high exit costs). Firms owning >5% of a company's market cap face significant liquidity problems on exit.
Explanation: B is correct: The net liquidity position of the manager has direct cost implications. A manager systematically crossing the spread (net demander) generates implicit transaction costs that reduce portfolio returns. The reading's specific thresholds (5-day and 10-day liquidation horizons) are practical benchmarks for assessing portfolio-level liquidity: a portfolio that requires more than 10 days to liquidate is effectively illiquid and may be difficult to exit in a crisis without severe price impact. The 5% market cap concentration threshold is a red flag because selling a large position representing 5%+ of market cap will move the price against the seller.
Question 158
What is the COST ADVANTAGE of using a pooled investment vehicle for trading, compared to an SMA?
Select an option first.
Correct answer: B — Pooled vehicles aggregate trades from all investors, enabling bulk execution at lower per-unit costs. For example, if 500 clients each want to buy $10,000 of a stock, a pooled fund buys one $5M block trade at lower market impact and potentially better execution than 500 separate $10K trades. SMAs must execute separate orders for each account, increasing total transaction costs. This aggregation benefit is one of the primary cost advantages of pooled vehicles over SMAs.
Explanation: B is correct: Trade aggregation is a genuine cost advantage. Institutional block trades often negotiate lower brokerage commissions per share than small retail-sized orders. A single $5M order has lower percentage market impact than five hundred $10K orders (individual small orders can actually collectively move the price more than one coordinated large order in some markets). The reading explicitly states that 'trading costs are relatively higher for SMAs because trades cannot be aggregated.' For tax-exempt institutional investors who don't need the SMA's tax advantages, the lower costs of pooled vehicles are often decisive.
Question 159
Why can PERFORMANCE-BASED FEE STRUCTURES lead to UNDERESTIMATION of downside risk using standard deviation?
Select an option first.
Correct answer: B — Performance-based fees transform the manager's gross return distribution (which is symmetrical) into a net return distribution that is asymmetrical. In periods of strong performance, a large fraction of gross returns is paid as fees (reducing net returns significantly). In periods of poor performance, the fee is floored at the base fee (fees don't turn negative). This creates a compressed upside in net returns but a full downside—a concave distribution. Standard deviation, which treats upside and downside symmetrically, will underestimate the actual downside risk of the net return distribution.
Explanation: B is correct: The reading states that performance-based fees 'transform symmetrical gross active return distributions into asymmetrical net active return distributions. The result is lower relative variance on the upside versus the downside. Therefore, by using a symmetrical risk measure such as standard deviation, there could be an underestimation of downside risk.' Consider: in great years, the investor keeps only a fraction of gross returns (after sharing). In bad years, the investor bears the full loss (no fee reduction in most bonus structures). Net return distribution: upside is clipped; downside is not. Standard deviation applied to this distribution understates true downside risk.
Question 160
What are the TWO important qualitative analysis questions about a manager's investment process, per the reading?
Select an option first.
Correct answer: B — (1) What is the likelihood that the same level of returns will continue in the future? (assessed through the four Ps: philosophy, process, people, portfolio—evaluating repeatability and consistency); and (2) Does the manager's investment process account for all the relevant risks? (assessed through operational due diligence: back office quality, asset safeguarding, reporting capabilities, and the robustness of risk management processes).
Explanation: B is correct: These two questions are the organizing framework for qualitative analysis. Question 1 (repeatability) addresses whether the past returns will recur—answered by examining philosophy consistency, process discipline, people stability (turnover), and portfolio congruence. Question 2 (risk accounting) examines operational integrity—can the manager actually execute the process safely? A manager with a brilliant philosophy and excellent past returns who has inadequate back-office systems for handling complex derivatives positions may create operational risks that manifest as future losses unrelated to the investment thesis. Both questions must be answered affirmatively before the manager is recommended.
Question 161
What is the difference between CLOSED-END FUND and OPEN-END FUND liquidity, and why do ETFs rank alongside closed-end funds in liquidity?
Select an option first.
Correct answer: B — Closed-end funds and ETFs trade on exchanges throughout the trading day (intraday liquidity)—you can buy or sell at market price at any time. Open-end funds (mutual funds) only allow subscriptions and redemptions at end-of-day NAV—no intraday trading. Both closed-end funds and ETFs have exchange-traded shares, hence comparable intraday liquidity. The key distinction: open-end fund shares can be created/redeemed with the fund directly (changing the fund's total shares outstanding), while closed-end fund shares trade between investors on the secondary market.
Explanation: B is correct: The reading ranks closed-end funds and ETFs at the top of the liquidity hierarchy because of intraday trading. An investor in a closed-end equity fund can sell their shares at 2:17pm on any business day—liquidity is limited only by the trading volume of the fund's shares. An open-end mutual fund investor who submits a redemption request at 2:17pm will receive NAV calculated at 4:00pm that day. For ETFs, the creation/redemption mechanism with authorized participants ensures the ETF price stays close to NAV even for intraday transactions, providing high liquidity with tight pricing.
Question 162
What is a GATE provision in a hedge fund contract, and why is it included?
Select an option first.
Correct answer: B — A gate provision limits the maximum percentage of fund assets that can be redeemed in any given redemption period (e.g., no more than 25% of fund assets can be redeemed in any one quarter). It protects remaining investors by preventing a self-reinforcing redemption spiral: if many investors try to redeem simultaneously, the manager may be forced to sell illiquid assets at depressed prices, harming remaining investors. The gate prevents first-mover advantages in redemptions.
Explanation: B is correct: Gates are a liquidity management tool for hedge funds with illiquid underlying positions. Without gates, a large market disruption could trigger simultaneous redemption requests. The manager would be forced to liquidate liquid positions quickly (often at fire-sale prices), leaving remaining investors with a portfolio of the least-liquid, hardest-to-value positions. Gates allow the manager time to liquidate positions in an orderly manner, protecting remaining investors. The reading distinguishes: lockup = no redemptions allowed for a fixed period after initial investment; gate = limits the redemption amount at any one time; notification period = advance notice required before redemption.
Question 163
Calculate the performance fee for a fund using a BONUS STRUCTURE: Base fee = 0.50%, sharing = 15% of positive active return, no cap. Benchmark = 8%, portfolio gross return = 12%. Total fee?
Select an option first.
Correct answer: A — 0.50% + 15% × 4% = 1.10%
Explanation: A is correct: Active return = portfolio return − benchmark = 12% − 8% = 4%. Performance fee = 15% × 4% = 0.60%. Total fee = base (0.50%) + performance fee (0.60%) = 1.10%. The bonus structure charges: Greater of (1) base only = 0.50%, or (2) base + 15% × positive active return = 1.10%. Since 1.10% > 0.50%, total fee = 1.10%. B is wrong—the bonus structure pays above base when performance is positive. C applies sharing to total gross return, not active return. D applies 15% to total gross return, not active return. A is the correct formula application.
Question 164
A manager claims their strategy naturally has a convex return profile due to systematic put purchases. How should this affect the due diligence analyst's assessment of manager SKILL?
Select an option first.
Correct answer: B — Convexity arising from put purchases is strategy-induced, not skill-based. The puts mechanically protect against downturns (reducing DC) but cost option premiums (reducing UC in stable markets). The analyst should not attribute the resulting CR > 1 to manager skill—it is simply the mechanical payoff profile of the options strategy. True skill-based convexity would come from a manager who successfully times defensive shifts and growth bets without paying the option premium. The analyst should compare the CR against the cost of the put protection to assess whether the strategy adds net value.
Explanation: B is correct: The reading explicitly distinguishes these two sources of convexity: 'Consider an example of a hedging strategy that involves buying a series of out-of-the-money puts prior to severe market downturns. The result is positive asymmetry with many small losses (low DC ratio) due to the puts expiring worthless with far fewer large gains in this scenario (high UC ratio).' This is mechanical, not skillful. The costs of the strategy (put premiums creating small losses in calm markets, reducing UC) are simply a different form of the same returns. The analyst must determine: is the net Sharpe ratio after accounting for put costs better than a simple benchmark allocation? Only if yes does the convex profile represent genuine value creation.
Question 165
Why is it important to track the subsequent performance of FIRED managers to control for Type II errors?
Select an option first.
Correct answer: B — Type II errors occur when a skilled manager is incorrectly fired (or not hired). The only way to measure whether a Type II error occurred is to observe what the fired manager subsequently achieved. If fired managers consistently outperform their replacements or the benchmark after being let go, this is strong evidence of systematic Type II errors in the evaluation process. Tracking also reveals whether the characteristics used to identify 'poor' managers (e.g., short-term underperformance) are genuinely predictive of future underperformance or merely noise.
Explanation: B is correct: The reading explicitly recommends tracking 'the subsequent performance of managers who were not hired as well as those who were fired' as the primary mechanism for detecting and reducing Type II errors. Without this feedback loop, the selection process cannot learn from its mistakes. If analysis reveals that fired managers outperform their replacements 70% of the time over subsequent 3 years, this signals: (1) the evaluation criteria are capturing noise rather than skill; (2) behavioral biases (e.g., recency bias—overreacting to recent underperformance) are causing premature terminations; and (3) systematic changes to the evaluation process are needed.
Question 166
What is the PRIMARY reason a manager's investment philosophy must be INTERNALLY CONSISTENT for the due diligence to be satisfied?
Select an option first.
Correct answer: B — Internal consistency ensures that the investment process, people, and portfolio will naturally align with the stated philosophy, making the alpha source repeatable. If the philosophy is inconsistent (e.g., believing in market efficiency but pursuing active management), the process will reflect that contradiction—either the manager doesn't really believe what they claim, or there is a fundamental logical flaw in the approach. Consistency also makes it easier to attribute performance attribution results back to the stated edge and to detect strategy drift.
Explanation: B is correct: The reading asks: 'Do the assumptions make sense and are they congruent with the investment process?' A manager claiming to exploit behavioral biases (believing markets are temporarily inefficient) who runs a purely passive index fund is logically inconsistent—their philosophy and process don't match. A manager who believes structural regulatory inefficiencies create long-term opportunities but runs a high-frequency trading strategy is also inconsistent. The consistency check in due diligence ensures the stated alpha source, the process for capturing it, the people skilled in executing it, and the resulting portfolio all tell the same coherent story.
Question 167
How does TEAM DIVERSITY reduce investment decision-making errors according to the reading?
Select an option first.
Correct answer: B — Social and cognitive diversity reduces groupthink by introducing genuinely different analytical frameworks, risk tolerances, and information sources into the team's deliberations. A team where every member has the same educational background, same cultural context, and same investment training will share similar blind spots. A cognitively diverse team (e.g., fundamental + quantitative + macro analysts) is more likely to surface information or perspectives that challenge the consensus, reducing the risk of overlooking contradictory evidence.
Explanation: B is correct: The reading explicitly states 'Team diversity, in terms of social and cognitive categories, has been shown to reduce groupthink and errors.' Social diversity (different backgrounds, experiences, perspectives) and cognitive diversity (different analytical approaches, mental models) each contribute independently. A team of 5 where all members are former Goldman Sachs equity analysts will bring similar frameworks. A team of 5 with fundamental, quant, macro, behavioral finance, and fixed-income backgrounds will challenge each other productively. The due diligence question about team diversity is specifically designed to probe whether the manager has built this structural protection against groupthink.
Question 168
What are the specific DISCLOSURE REQUIREMENTS for non-fee-paying portfolios included in composites under GIPS?
Select an option first.
Correct answer: B — Non-fee-paying portfolios may be included in a composite but are not required to be. If included, firms must disclose the percentage of composite assets represented by non-fee-paying portfolios. This is important because including non-fee-paying portfolios (e.g., the firm's own seed capital) in composites without disclosure could make composite returns appear higher than what fee-paying clients actually earned—since non-fee-paying accounts have lower cost drag.
Explanation: B is correct: The reading states 'Non-fee-paying portfolios may be included in a composite, but the firm is not required to. If included, firms are required to disclose the percentage of composite assets represented by non-fee-paying portfolios.' The disclosure requirement exists because composite returns are supposed to represent what actual paying clients experienced. If the firm manages its own $100M seed capital portfolio alongside $50M of client assets, and the seed capital performs better (no fee drag), the composite return will be skewed upward. Disclosure lets prospective clients adjust for this. Seed capital started to test a new strategy is specifically addressed—it can be included in composites but must be disclosed as non-fee-paying.
Question 169
A pension fund is considering two managers for a core equity mandate. Manager A: past 5-year annual return = 12%, tracking error = 8%, IR = 0.40. Manager B: 5-year return = 11%, tracking error = 3%, IR = 0.50. Which manager is preferable for a risk-conscious pension fund and why?
Select an option first.
Correct answer: B — Manager B — higher IR (0.50 vs. 0.40) indicates more consistent alpha per unit of active risk. For a pension fund with liability-matching constraints, tracking error is a critical consideration. Manager B's lower tracking error (3% vs. 8%) means the portfolio stays closer to the benchmark, reducing the risk of a large shortfall relative to liabilities. Despite lower absolute returns (11% vs. 12%), Manager B's more consistent excess return generation makes it the superior choice for a risk-conscious institutional investor.
Explanation: B is correct: IR = active return / tracking error. Manager B's IR of 0.50 (vs. 0.40) means they generate more active return per unit of benchmark-relative risk. For a pension fund with specific liability matching constraints, tracking error vs. the liability benchmark is a critical risk. A high-tracking-error manager (Manager A: 8%) creates significant risk of underperforming the liability benchmark in any given year, potentially widening the funding gap. Manager B's 3% tracking error provides better liability-relative stability. The 1% annual return advantage of Manager A is insufficient to compensate for the dramatically higher benchmark-relative risk in a liability-driven context.
Question 170
What is the difference between REDEMPTION FREQUENCY and NOTIFICATION PERIOD in a hedge fund limited partnership agreement?
Select an option first.
Correct answer: B — Redemption frequency refers to how often an investor is permitted to submit redemption requests (e.g., quarterly or monthly). Notification period refers to the advance notice the investor must give before the redemption date (e.g., 45 days before quarter-end). Both restrict effective liquidity: an investor who wants to exit must plan ahead by the notification period and can only do so at the redemption frequency dates.
Explanation: B is correct: The reading defines both terms as components of hedge fund liquidity. Consider a fund with quarterly redemptions and 45-day notice: an investor who decides to exit on March 1 must submit notice by March 16 (45 days before June 30 quarter-end). If they miss that window, the next redemption date is September 30, requiring notice by August 16. Effective liquidity is therefore much less than 'quarterly'—an investor needing funds on April 1 could be locked in until September 30. The combination of redemption frequency, notification period, lockup, and gates determines the actual liquidity profile of a hedge fund investment.
Question 171
What are the advantages of LIMITED PARTNERSHIP structures for managers investing in ILLIQUID assets?
Select an option first.
Correct answer: B — Key advantages: (1) Long investment horizon—LP lock-ups prevent investors from forcing premature liquidations that would destroy value in illiquid positions; (2) Illiquidity premium capture—the manager can invest in assets that require long holding periods to realize value (PE, real estate, infrastructure) without being forced to sell at temporary lows to meet redemptions; (3) Protection from distressed selling—lock-ups prevent investors from redeeming during market crises when illiquid assets would need to be sold at deeply distressed prices.
Explanation: B is correct: The reading frames LP structure lock-ups as investor-protection tools in the context of illiquid strategies: 'allowing for the earning of illiquidity premiums by investing in illiquid assets and not being forced to sell assets at depressed prices due to redemption requests.' A private equity manager who cannot be forced to exit portfolio companies on an investor's timetable has the flexibility to hold until the ideal exit environment (IPO window, strategic buyer). Without LP structure protections, a manager would need to hold only liquid assets to meet potential redemptions—sacrificing the illiquidity premium that justifies the strategy.
Question 172
What does the reading identify as the PRIMARY purpose of OPERATIONAL DUE DILIGENCE in the qualitative analysis of investment managers?
Select an option first.
Correct answer: B — Operational due diligence is designed to identify risks NOT evident in the firm's past returns—operational failures, inadequate controls, custody risks, and systemic weaknesses that could cause future losses through non-investment-related events (e.g., fraud, operational error, cybersecurity failure, or settlement failure). It examines: quality of back office, ability to safeguard assets, reporting capabilities, and overall firm sustainability. A manager with excellent investment returns but poor back-office controls may generate hidden tail risks.
Explanation: B is correct: Operational due diligence is deliberately distinct from investment due diligence because returns alone don't reveal operational risks. The Madoff fraud is the extreme example: investment due diligence on returns suggested excellent risk-adjusted performance; operational due diligence (examining the custody, auditing, and trade confirmation process) would have revealed massive red flags. The reading frames operational DD as examining 'the process and procedures of the firm' for 'aspects such as the quality of the back office, the ability to safeguard assets, and the ability to prepare useful reports on a timely basis.' These are infrastructure questions, not investment-quality questions.
Question 173
Calculate: Modified Dietz return for a portfolio with BV = $5M, EV = $5.3M, one ECF: inflow of $200K on Day 10 of a 30-day month.
Select an option first.
Correct answer: A — 1.92%
Explanation: A is correct: Modified Dietz formula: R = (EV − BV − ECF) / (BV + W × ECF). Weight of ECF = (30 − 10) / 30 = 20/30 = 0.6667 (days remaining after cash flow / total days). Numerator = $5.3M − $5M − $0.2M = $0.1M. Denominator = $5M + 0.6667 × $0.2M = $5M + $0.1333M = $5.1333M. R = $0.1M / $5.1333M = 1.948% ≈ 1.92%. A is correct. B (2.00%) = $0.1M/$5M ignoring ECF adjustment. C (1.85%) uses slightly different weight. D (2.15%) overstates. The Modified Dietz gives credit to the manager only for the time the ECF was actually available to invest (20 of 30 days).
Question 174
A manager uses a SOFT LOCKUP with a 3% redemption fee in the first year. An investor with $10M redeems after 8 months. What does the investor receive net of the soft lockup fee?
Select an option first.
Correct answer: A — $10M × (1 + 8-month return) × (1 − 3%) net
Explanation: A is correct: A soft lockup permits redemptions during the lockup period but charges a penalty fee (in this case, 3%) on the redeemed amount. If the portfolio grew to $10.5M over 8 months, the investor receives $10.5M × (1 − 3%) = $10.5M × 0.97 = $10.185M. The soft lockup is different from a hard lockup (which prohibits all redemptions during the period without exception). The reading defines soft lockup as 'permits redemptions for a fee.' The 3% penalty partially compensates the remaining investors for the disruption of the early redemption. A correctly shows the net-of-fee calculation.
Question 175
A fund's gross return was +6%. It charges a SYMMETRICAL fee of base 1% plus 20% sharing of active return, where active return is measured vs. a benchmark return of 4%, and sharing is applied to the active return NET OF BASE FEE. What is the total fee?
Select an option first.
Correct answer: A — 1% + 20% × (2% − 1%) = 1.20%
Explanation: A is correct: Active return = 6% − 4% = 2%. Active return net of base fee = 2% − 1% = 1%. Performance fee = 20% × 1% = 0.20%. Total fee = 1% + 0.20% = 1.20%. A is correct. B applies sharing to full active return (2%) before subtracting the base fee: 1% + 20% × 2% = 1.40%. C applies sharing to gross return: 1% + 20% × 6% = 2.20%. Both B and C misapply the 'net of base fee' modifier. The symmetrical structure's downside would apply negative sharing when gross return underperforms: e.g., if gross = 2% and benchmark = 4%, active = −2%, net of base = −3%, sharing = 20% × (−3%) = −0.60%, total fee = 1% − 0.60% = 0.40%.
Question 176
Why does GIPS recommend that benchmark returns must be TOTAL RETURN benchmarks (not price-only) for performance comparisons?
Select an option first.
Correct answer: B — Total return benchmarks include both price appreciation and income (dividends for equities, coupons for bonds). Using a price-only benchmark (which excludes income) would artificially make the manager's total return look superior simply because the manager earns income that the benchmark ignores. For income-generating assets (bonds, dividend stocks), this distortion can be substantial. Total return benchmarks ensure apples-to-apples comparison: the portfolio's total return is compared to the benchmark's total return.
Explanation: B is correct: The reading states 'benchmarks must reflect the corresponding investment strategy and must be total return benchmarks, not price-only benchmarks.' Consider a bond manager whose portfolio earns 5%: 2% from price appreciation + 3% from coupon income. If the benchmark is price-only and shows 2% return, the manager appears to outperform by 3%—but this is purely the coupon income, not skill. A total return benchmark of 5% (including coupons) correctly shows no active management outperformance. The requirement for total return benchmarks prevents the misleading practice of comparing portfolio total returns against price-only index returns.
Question 177
Under GIPS, what is the MINIMUM GIPS compliant performance history required when a firm initially claims compliance?
Select an option first.
Correct answer: B — At least 5 years of GIPS-compliant annual performance must be presented upon initial compliance—or the period since firm inception if the firm is less than 5 years old. After initial compliance, the firm must extend the record by one year annually until reaching a 10-year compliant history. After 10 years, the 10-year compliant record must be maintained.
Explanation: B is correct: The reading specifies: 'Upon GIPS adoption, firms are required to present GIPS compliant annual performance for at least 5 years (unless the composite has been in existence for less than 5 years). And then extended each year until the firm builds a 10-year GIPS compliant history.' A firm that has been in existence for 3 years must present 3 years of compliant performance on initial adoption, then extend to 4 years the following year, and so on until reaching 10 years. This 5-year minimum requirement is frequently tested on the CFA exam as a foundational GIPS compliance requirement.
Question 178
What distinguishes a HARD LOCKUP from a SOFT LOCKUP, and from a GATE, in a hedge fund LP agreement?
Select an option first.
Correct answer: B — Hard lockup: absolutely prohibits all investor redemptions during the specified period (typically 1–2 years from initial investment)—no exceptions regardless of circumstances. Soft lockup: permits redemptions during the lockup period but charges a penalty fee (e.g., 3–5% of redeemed amount), effectively discouraging but not prohibiting early exit. Gate: limits the total redemption amount at any given redemption date (e.g., maximum 25% of fund NAV can be redeemed in any quarter), managing the pace of capital outflows rather than blocking them entirely.
Explanation: B is correct: The three mechanisms operate at different levels and with different purposes. Hard lockup: binary prohibition—you cannot leave, period. Protects long-horizon strategies from forced early liquidation. Soft lockup: economic discouragement—you can leave but it costs you. Often used in hedge funds to cover the administrative and market-impact costs of early redemption while preserving investor flexibility. Gate: flow management—you can leave but not all at once. Prevents a 'bank run' dynamic where simultaneous redemptions force fire sales. In combination: a fund might have a 1-year hard lockup, quarterly redemptions thereafter with 45-day notice, a 25% gate, and no soft lockup fee after the hard lockup period.
Question 179
What is the MONITORING component of the investment decision-making process, and what does it examine?
Select an option first.
Correct answer: B — Portfolio monitoring examines both external factors (macroeconomic environment, market conditions, and their impact on the manager's ability to exploit the targeted inefficiency) and internal factors (historical returns, current risk levels, position sizes, and allocations). It checks for significant deviations from the investment process (style drift) and ensures investment decisions remain congruent with the most current client IPS objectives. Monitoring is the ongoing quality-control step that validates the process remains intact.
Explanation: B is correct: The reading describes the four-step investment process as: Idea Generation → Idea Implementation → Portfolio Construction → Portfolio Monitoring. Monitoring closes the feedback loop. External factors: if the macro environment changes (e.g., central bank policy shifts), does the manager's stated inefficiency still exist? A manager exploiting yield curve shape anomalies needs to reassess when the central bank fundamentally changes its operating framework. Internal factors: are positions within risk limits? Has turnover deviated from what the philosophy implies? Style drift detected through RBSA/HBSA during ongoing monitoring is particularly important for composite integrity.
Question 180
A fund has: gross return 15%, benchmark 8%. Performance fee = greater of: base 0.5%, OR base + 25% sharing of active return above 2% hurdle, capped at max total fee of 3%. Calculate the total management fee.
Select an option first.
Correct answer: A — 0.5% + 25% × (7% − 2%) = 1.75%
Explanation: A is correct: Active return = 15% − 8% = 7%. Hurdle rate = 2%. Active return above hurdle = 7% − 2% = 5%. Performance fee = 25% × 5% = 1.25%. Total = 0.5% base + 1.25% = 1.75%. Is 1.75% > cap of 3%? No — cap not binding. Is 1.75% > base of 0.5%? Yes — bonus applies. Total fee = 1.75% = A. B applies 25% to full 7% active return without subtracting the 2% hurdle: 0.5% + 25% × 7% = 2.25%. C would require total = 0.5% + 25% × 10% = 3.0% (cap triggers only at active return above hurdle of 12%: 25% × 12% + 0.5% = 3.5%, capped at 3%). D is wrong — active return (7%) far exceeds the 2% hurdle.
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