I am looking at ST5 April 2015 Question 5 (ii)(b) which requires calculation of stock selection profit at the individual asset class level. I'm aware the formula for this is actual sector weight *(actual sector return – notional sector return) and in this case this needs to be calculated over a 3-year period. However in this case the portfolio is not rebalanced, so the weight changes each year. So my question is is it correct to just use the starting weight to calculate the stock selection profit from each asset class? It feels like as the weights change over time the actual contribution would change too but i'm not sure. Thanks.
Unfortunately no. You have to work out what the weightings are in the actual fund and in the benchmark at the start of each year. So for example the actual fund, invested in equities should start at 0.25 becomes 0.263 then 0.2349 then 0.2144 given the performance of all the assets over each year. Do the same for the benchmark and you have your weights for the asset allocation and sector selection. The ActEd ASET has all the calcs, but there are too many for a forum post.
Thanks Colin, that makes sense logically. In the example of April 15Q5 however it seems like they've just applied the starting weight? For example, the index-linked fund return is 76% and the notional return is 61% with the starting weight at 0.5. So it looks like they've done 0.5*(76.24%-61.67%) = 7.28%. despite the portfolio not rebalancing. I don't have ASET unfortunately so can't see if this is explained in there.
Good point. I have scrolled up in the ActEd ASET and we give two solutions. One the way the examiner did it which was using on the weighting at the start of the three years. And then the "alternative" which analyses it by year, and adjusts the weighting each year. Both would have scored marks.
