Explanation:
The information ratio (IR) of a fund manager is influenced by the number of transactions they carry out, also known as the breadth of the strategy (BR). In this scenario, the firm's management has capped transactions at 100 per year. However, the 100 transactions executed by a fund manager may not all be distinct. For example, the fund manager might be investing in growth stocks and perform 20 transactions related to this. While these may appear as 20 separate transactions, they are all correlated. This correlation between the different bets of the fund manager reduces the breadth of the strategy, and consequently, the information ratio. Therefore, the correlation between the different bets of the fund manager is the most likely reason for the observed information ratio of less than 0.75.
Choice B is incorrect. The cap on the number of transactions per year does not directly affect the information ratio. The information ratio measures the excess return of a portfolio over its benchmark, relative to the consistency of that excess return (tracking error). While transaction costs can impact returns, they do not directly influence the calculation of an information ratio.
Choice C is incorrect. Differences in portfolio weights can lead to differences in returns and risk levels between portfolios, but they do not directly affect the calculation of an information ratio. The information ratio is a measure of risk-adjusted performance and does not depend on portfolio weights.
Choice D is incorrect. Differences in the number of transactions from one manager to another could potentially impact transaction costs and thus returns, but this would not directly influence an information ratio calculation which focuses on excess return over benchmark relative to tracking error.
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Q.2417 An investment management firm recruits multiple fund managers to manage its funds. In order to have some control over transaction costs, the firm allows each manager to make a maximum of 100 transactions per year. One of the fund managers alternatively calculates her information ratio by computing the excess return and the tracking error from the actual observed values. She uses the following formula:
Where: IR is the information ratio.
IC is the information coefficient.
BR is the breadth of the strategy. Suppose that IC is assumed to be 7.5%. After computation, the fund manager observes that the information ratio is less than 0.75. This is most likely due to the:
A
Correlation between the different bets of the fund manager.
B
Cap on the number of transactions per year.
C
Differences in portfolio weights.
D
Differences in the number of transactions from one manager to another.