CIPM Level II cheat sheet

Time-weighted return (TWR) neutralizes external cash flows by geometrically linking sub-period returns; it measures the manager's investment decisions and is the standard for manager evaluation under GIPS.

Money-weighted return (MWR), equivalent to IRR, reflects both manager decisions and the timing/size of client cash flows; it answers the client's actual experience question, not the manager skill question.

Modified Dietz approximates MWR for a period by weighting each external flow by the fraction of the period it was held: R = (V_E − V_B − CF) / (V_B + Σ w_i·CF_i), with w_i = (D − d_i)/D.

True daily valuation with sub-period linking is required when large external cash flows occur; a common threshold is 10% of portfolio value, but the governing policy document sets the actual trigger.

Geometric linking formula: (1+R_total) = Π(1+R_t) across sub-periods; arithmetic averaging overstates multi-period performance because it ignores compounding volatility drag.

Annualized return from a cumulative multi-year return: (1+R_cum)^(1/n) − 1, where n is years; do not annualize periods shorter than one year for reporting purposes.

Benchmark selection rules: the benchmark must be investable, specified in advance, consistent with the mandate's style and risk, and the manager must be measured against the same benchmark used to hire them.

Attribution decomposes excess return into allocation (weight differences × benchmark segment returns) and selection (segment weight × within-segment excess return); interaction terms must be assigned explicitly.

Risk-adjusted measures: Sharpe uses total volatility; Treynor and Jensen's alpha use beta (systematic risk); information ratio = active return / tracking error versus the designated benchmark.

Mandate definition precedes the search: asset class, benchmark, risk budget, liquidity needs, constraints (e.g., no tobacco, max single-issuer), and permissible derivatives must be documented before screening.

Minimum screening criteria typically include track record length (commonly 3–5 years or one full market cycle), assets under management range, strategy capacity, ownership stability, and GIPS compliance status.

Survivorship bias inflates the apparent skill of a manager universe because failed or closed products drop out; insist on a survivorship-free database and ask for terminated-product history.

Backfill bias inflates early track record returns because managers choose when to begin reporting; ask for the inception-to-reporting gap and the firm's composite inclusion policy.

Performance evaluation must separate luck from skill: use t-statistics on excess return, consistency ratios (percentage of periods beating benchmark), and style-consistency checks (returns-based or holdings-based).

Organizational due diligence covers key-person dependence, compensation structure, ownership succession, staff turnover, compliance/regulatory history, and alignment of the manager's own capital.

Operational due diligence covers trade allocation fairness, best execution, valuation policy for illiquid holdings, custody arrangements, business continuity, and cybersecurity controls.

Finalist selection uses a scored matrix with pre-agreed weights across quantitative (risk-adjusted return, drawdown, tracking error) and qualitative (process, people, operations) factors; document scores before meeting finalists.

Fees must be compared on an all-in basis (management fee, performance fee with high-water mark, custody, trading costs); a lower headline fee with higher turnover can cost more net of trading.

Time-weighted return (TWR) neutralizes external cash flows by geometrically linking sub-period returns; it measures the manager's investment decisions and is the standard for manager evaluation under GIPS.

Money-weighted return (MWR), equivalent to IRR, reflects both manager decisions and the timing/size of client cash flows; it answers the client's actual experience question, not the manager skill question.

Modified Dietz approximates MWR for a period by weighting each external flow by the fraction of the period it was held: R = (V_E − V_B − CF) / (V_B + Σ w_i·CF_i), with w_i = (D − d_i)/D.

True daily valuation with sub-period linking is required when large external cash flows occur; a common threshold is 10% of portfolio value, but the governing policy document sets the actual trigger.

Geometric linking formula: (1+R_total) = Π(1+R_t) across sub-periods; arithmetic averaging overstates multi-period performance because it ignores compounding volatility drag.

Annualized return from a cumulative multi-year return: (1+R_cum)^(1/n) − 1, where n is years; do not annualize periods shorter than one year for reporting purposes.

Benchmark selection rules: the benchmark must be investable, specified in advance, consistent with the mandate's style and risk, and the manager must be measured against the same benchmark used to hire them.

Attribution decomposes excess return into allocation (weight differences × benchmark segment returns) and selection (segment weight × within-segment excess return); interaction terms must be assigned explicitly.

Risk-adjusted measures: Sharpe uses total volatility; Treynor and Jensen's alpha use beta (systematic risk); information ratio = active return / tracking error versus the designated benchmark.

Mandate definition precedes the search: asset class, benchmark, risk budget, liquidity needs, constraints (e.g., no tobacco, max single-issuer), and permissible derivatives must be documented before screening.

Minimum screening criteria typically include track record length (commonly 3–5 years or one full market cycle), assets under management range, strategy capacity, ownership stability, and GIPS compliance status.

Survivorship bias inflates the apparent skill of a manager universe because failed or closed products drop out; insist on a survivorship-free database and ask for terminated-product history.

Backfill bias inflates early track record returns because managers choose when to begin reporting; ask for the inception-to-reporting gap and the firm's composite inclusion policy.

Performance evaluation must separate luck from skill: use t-statistics on excess return, consistency ratios (percentage of periods beating benchmark), and style-consistency checks (returns-based or holdings-based).

Organizational due diligence covers key-person dependence, compensation structure, ownership succession, staff turnover, compliance/regulatory history, and alignment of the manager's own capital.

Operational due diligence covers trade allocation fairness, best execution, valuation policy for illiquid holdings, custody arrangements, business continuity, and cybersecurity controls.

Finalist selection uses a scored matrix with pre-agreed weights across quantitative (risk-adjusted return, drawdown, tracking error) and qualitative (process, people, operations) factors; document scores before meeting finalists.

Fees must be compared on an all-in basis (management fee, performance fee with high-water mark, custody, trading costs); a lower headline fee with higher turnover can cost more net of trading.