CIPM Level I cheat sheet

Time-weighted return (TWR) eliminates the effect of external cash flows; it is the required method for GIPS-compliant performance reporting and measures the manager's investment skill.

Money-weighted return (MWR), typically the IRR of all cash flows, reflects both manager decisions and the timing/size of client contributions and withdrawals; it is appropriate for client reporting when the manager controls cash flow timing.

Simple Dietz: R = (V1 − V0 − CF) / (V0 + 0.5 × CF), where CF is the net external flow; it approximates TWR and is acceptable only when flows are large relative to portfolio value or occur near mid-period.

Modified Dietz weights each external cash flow by the fraction of the period it remains invested: R = (V1 − V0 − ΣCF) / (V0 + Σ[CF × w]), with w = (CD − Di)/CD; it is an approximation, not a true TWR.

True daily valuation TWR compounds sub-period returns: TWR = Π(1 + rt) − 1, where each rt is computed between external cash flow dates using beginning and ending market values net of flows.

Geometric linking is required for multi-period TWR; arithmetic linking (summing sub-period returns) overstates compounded performance and is not acceptable for reporting.

The Brinson–Fachler attribution model decomposes active return: allocation effect = Σ[(wp − wb) × (rb − rb_total)]; selection effect = Σ[wb × (rp − rb)]; interaction = Σ[(wp − wb) × (rp − rb)].

In Brinson attribution, a positive allocation effect means the manager overweighted sectors that outperformed the benchmark's overall return; selection effect isolates security picking within sectors relative to the benchmark sector return.

The interaction term captures the joint effect of weighting and selection; some firms combine interaction with selection or allocation, but the choice must be disclosed and applied consistently.

Attribution effects are additive to active return only when the arithmetic Brinson approach is used; geometric attribution (e.g., Menchero, GRAP) is needed when compounding effects must reconcile exactly.

Sharpe ratio = (Rp − Rf) / σp, using total risk (standard deviation of returns); it is appropriate for a portfolio that represents the investor's entire risky holdings.

Treynor ratio = (Rp − Rf) / βp, using systematic risk; it is appropriate for a well-diversified portfolio or one component of a larger diversified portfolio.

Jensen's alpha = Rp − [Rf + βp × (Rm − Rf)]; it measures the excess return over CAPM-required return and is expressed in the same units as the return.

M² (Modigliani–Modigliani) = (Rp − Rf) × (σm / σp) + Rf; it scales the portfolio's risk to that of the market, enabling direct comparison of risk-adjusted returns in return units.

Information ratio = (Rp − Rb) / tracking error, where tracking error is the standard deviation of active returns (Rp − Rb); it measures active return per unit of active risk.

Sortino ratio replaces total standard deviation with downside deviation, focusing only on returns below a target; it is preferred when return distributions are asymmetric.

The appraisal ratio = alpha / residual standard deviation (from a multi-factor regression); it measures value added per unit of idiosyncratic risk not explained by factors.

Risk-adjusted performance measures must be computed over a consistent period and frequency; Sharpe and Treynor ratios are not comparable across different measurement intervals without annualization.

A statistically insignificant alpha (t-stat below roughly 2) does not provide reliable evidence of skill; performance appraisal should consider statistical significance and the number of observations.

GIPS compliance is firm-wide: a firm may claim compliance only if it applies the GIPS standards to all actual, fee-paying, discretionary portfolios included in at least one composite.

Composites must include all actual, fee-paying, discretionary portfolios that meet the composite definition; firms may not selectively exclude portfolios to improve reported performance.

GIPS requires time-weighted total returns, net of actual trading expenses, computed at least monthly and geometrically linked; portfolios must be valued at least monthly and on the date of all large cash flows.

For periods beginning on or after 1 January 2010, firms must present at least five years of GIPS-compliant performance, building to ten years; if the firm has been in existence less than five years, performance since inception must be shown.

Required disclosures include the composite description, benchmark description, fee schedule, composite assets and firm assets, number of portfolios, internal dispersion, and the GIPS compliance statement.

The GIPS compliance statement must read: '[Firm] claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards.' It must also state that GIPS compliance has been verified or not verified.

Verification is performed by an independent third party and tests firm-wide compliance with GIPS; it does not ensure the accuracy of any specific composite presentation, and a firm may claim compliance without being verified.

Net-of-fee returns must reflect the deduction of actual investment management fees; if model fees are used, the firm must disclose that the returns are net of model fees and describe the model.

GIPS does not require a specific return calculation methodology beyond TWR, but firms must disclose the method used (e.g., original Dietz, Modified Dietz, daily valuation) and apply it consistently.

The GIPS standards are ethical standards for presentation, not a regulatory requirement; local laws and regulations take precedence, and firms must disclose any conflicts with local requirements.