Connell highlights the importance of style analysis to assess a manager’s risk exposure relative to a benchmark. She asserts:
Statement 4: Applying holdings-based style analysis to thinly traded or non-public companies would be preferable to a returns-based approach when prices tend to be sticky.
Twimbly counters:
Statement 5: Returns-based analysis tends to be static rather than dynamic.
- Concerning Twimbly’s and Connell’s assessments of style analysis, which statement(s) is(are) correct?
A. Only Statement 4
B. Only Statement 5
C. Both Statement 4 and Statement 5
Answer. B
LOS: Volume 5, Learning Module 4, Describe uses of returns-based and holdings-based style analysis in investment manager selection.
Statement 5 is correct. The disadvantage is that RBSA [returns-based style analysis] is an imprecise tool. Although the additional computational effort required is not onerous, accuracy may be compromised, because RBSA effectively attributes performance to an unchanging average portfolio during the period. This attribution limits the ability to identify the impact of dynamic investment decisions and may distort the decomposition across sources of added value. Furthermore, the portfolio being analyzed might not reflect the current or future portfolio exposures.
By this same logic, Statement 4 would be incorrect as portfolios with illiquid holdings (e.g., private equity, venture capital) would likely contain outdated prices, thereby understating the portfolio’s true risk exposure.
Reference: 2024, Investment Manager Selection, L3, Volume V, Learning Module 4, Section 4, Quantitative Elements of Manager Search and Selection, pp. 276-279.