various measures of evaluating performance of an actively managed portfolio

The opinions expressed are as of the date written and are subject to change without notice. This Balanced Scorecard is designed to measure the performance of funds under the active portfolio management approach. In a positive note, the data suggests that the average active dollar has outperformed the average active fund; this implies that investors have favored cheaper, higher-quality funds. Most professional money managers use a Global Investment Performance Standards (GIPS) compliant methodology to calculate investment performance. The greater the slope (higher number) the better the asset. Sharpe’s measure: (r p-r f)/s p. This measures the reward to total volatility trade-off. Each index is unmanaged and is not available for direct investment. This article contains certain forward-looking statements. This blog post is adapted from research that was originally published in  Morningstar Direct TM . The measures you choose will depend on the information you're looking for and the types of investments you own. This is appropriate when the objective is to measure the performance of overall portfolios that contain the entire wealth of the investor. What about an all-equity portfolio comprised of large-cap, small-cap, international, REITs and emerging markets? Active funds’ success rates fell versus 2017 in 16 of the 20 categories we examined. 4 key takeaways from Morningstar’s U.S. Active/Passive Barometer, We've published a new report. Investment managers have various incentives to evaluate the performance of the portfolios ... or the aggregate of all of the portfolios managed by an investment manager according to a ... formance evaluation. How do these trends apply globally? Most advisers have software that can calculate this. Active Funds: Cost . • Performance Management – Measurement of risk and return • Performance Attribution - Identifying and quantifying the sources of performance of portfolio includes asset class investment weights, exposure to market sectors, individual assets within mkt. Interestingly, GIPS does not require investment performance to be reported net of fees. The Kiplinger Washington Editors, Inc., is part of the Dennis Publishing Ltd. Group.All Contents © 2020, The Kiplinger Washington Editors, This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. The barometer is unique in the way it measures active managers’ success relative to the actual, net-of-fee performance of passive funds rather than an index, which isn’t investable. Our debate got me to thinking: How should the average investor measure investment performance? Treynor Portfolio Performance Measure. The declines were greatest among active foreign stock funds, which were disproportionately affected by the downdraft in overseas equity markets. Individual index information is provided as a reference only. Performance evaluation improves the effectiveness of a fund's investment policy by acting as a feedback and control mechanism. Investors should ask their adviser for their specific account’s performance net of all fees. A. the markets are efficient B. portfolio risk is constant over time C. diversification pays off D. security selection is more valuable than asset allocation Follow this estate planning checklist for you (and your heirs) to hold on to more of your hard-earned money. Those fees vary from 0.25% to 1.00% of the amount of the transaction, depending on the fund. Terms of Use Privacy Policy Disclosures Member User Agreement Corrections Cookies. Specifi­cally, we calculate the equal- and asset-weighted performance of the cohort of index-tracking (“passive”) options in each category that we examine, and we use that figure as the hurdle that defines success or failure for the active funds in the same category. These are as follows: Gross and net return A gross return is earned prior to the deduction of fees (management fees, custodial fees, and other administrative expenses). Still, most active managers’ long-term track records leave much to be desired. He is a graduate of the University of North Carolina at Chapel Hill and is a CERTIFIED FINANCIAL PLANNER™ professional. The risk-free rate plus the portfolio's beta times the difference between the average market returns and the risk-free rate. I’ve seen brokerage statements list a client’s various mutual fund’s performance, but not include the client’s overall account performance. How can investors gauge their performance relative to other alternatives? The Conventional Theory of Performance Evaluation: Comparing across funds. The average ongoing management expense of an actively-managed fund costs 1% more than its passively managed cousin. You can check adviser records with the. p f p r r Portfolio: (16 – 6)/20 = 0.5 Market: (14 – 6)/24 = 0.33 Treynor Measure = Ratio of portfolio excess return to beta. Most of the best healthcare stocks for 2021 will have some sort of ties to COVID, whether it's producing a vaccine or cure, or benefiting from the vir…. Today, there are three sets of performance measurement tools to assist with portfolio evaluations. The term within the square brackets is CAPM's predictions of the portfolio's returns. It does the following: 1. A performance measure is useful, for example, in ranking the performance of mutual funds. The different components of a portfolio and their weightings contribute to the extent to which the portfolio is exposed to various risks. I recommend investors focus on two components of performance: How is my account doing relative to a fair benchmark? Morningstar provides a quarterly list of average returns by category, which is a reasonable basic benchmark to measure a specific fund. Beta is the measure of an investment’s volatility to another market index, such as the S&P 500. Fund B. C. Fund C. Since indexes and/or composition levels may change over time, actual return and risk characteristics may be higher or lower than those discussed. The Sharpe ratio, also known as the reward-to-variability ratio, is perhaps the most common portfolio management metric. footnote * A few Vanguard mutual funds charge special purchase or redemption fees that are paid directly to the funds to help cover higher transaction costs and protect long-term investors by discouraging short-term, speculative trading. All told, about 35% of active funds beat the passive composite for their category in 2018. Dow Jones Industrial Average, S&P 500, Nasdaq, and Morningstar Index (Market Barometer) quotes are real-time. Apply the Sharpe ratio, M2 measure, Treynor ratio, Jensen’s alpha, and information ratio to evaluate portfolios. While an obsession with performance can be counterproductive (often leading to chasing past winners and inferior performance), an annual review of portfolio performance is something all investors should undertake. Mathematically, it refers to the extent of dispersion for a population of observations. You want to evaluate three mutual funds using the Sharpe measure for performance evaluation. The information contained herein is the proprietary property of Morningstar and may not be reproduced, in whole or in part, or used in any manner, without the prior written consent of Morningstar. Portfolio Standard Deviation. Actively-managed funds start at a disadvantage when compared to index funds. The Kiplinger Letter forecasts President-Elect Joe Biden’s biggest priorities -- and the likelihood of progress on them. Investors shouldn't be obsessed with their portfolio's performance, but an annual evaluation is key to keeping you on track. The  Morningstar Active/Passive Barometer is a semiannual report that measures the performance of actively versus passively managed funds within their respective Morningstar Categories. Ben Johnson, Morningstar Research Services LLC. The excess return of … The portfolio performance evaluation can be made based on the following methods: Sharpe’s Measure; Treynor’s Measure; Jensen’s Measure; 1. Fund A. While the basic return and risk measures and the risk-adjusted performance measures aim at evaluating the overall performance of the actively-managed portfolio, the primary application of the performance attribution The investment with the highest Sharpe measure is A. Although Index performance data is gathered from reliable sources, we cannot guarantee its accuracy, completeness or reliability. What about benchmarks? Should you benchmark your portfolio versus an index like the S&P 500? Beta. Mr. Palmer is a member of several professional organizations, including the National Association of Personal Financial Advisors (NAPFA) and past member of the TIAA-CREF Board of Advisors. They construct and manage their own portfolio of securities. This measure provides valuable insight if your goal is to look at investment return volatility. We share more actively versus passively managed fund trends in our European Active/Passive Barometer. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Performance evaluation’s place in portfolio management is shown in Exhibit 1, which illustrates a model of the investment management process as an integrated set of activities aimed at attaining investor objectives.2 2 1 In this reading, the terms “asset owners” and “clients”—that is, … The risk-free return during the sample period is 5%. Example: Calculating the Sharpe Ratio What’s a fair comparison for a portfolio invested 65% equity / 35% fixed? Shows where the policy and allocation is effective and where it isn't. I’ve spent over 25 years in the financial advisory profession but recently had a startling realization about investment performance. The Sharpe Ratio is defined as the portfolio risk premium divided by the portfolio risk: Sharpe ratio=Rp–RfσpSharpe ratio=Rp–Rfσp The Sharpe ratio, or reward-to-variability ratio, is the slope of the capital allocation line (CAL). Read takeaways from our latest Active/Passive Barometer. B. For example, an active manager in the U.S. large-blend Morningstar Category is measured against a composite of the performance of its index mutual fund and exchange-traded fund peers Vanguard Total Stock Market Index ( VTSMX), SPDR S&P 500 ETF ( SPY), and so on. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. This site is protected by reCAPTCHA and the Google the risk-adjusted performance measures and the performance attribution techniques. A benchmark portfolio should be 1) a viable alternative, 2) not easily beaten, 3) low in cost, and 4) identifiable before the fact. The method adopted by Sharpe is to rank all portfolios on the basis of evaluation measure. Mike Palmer has over 25 years of experience helping successful people make smart decisions about money. On the other hand, if you're a buy-and-hold investor more concerned a… We’ve rounded up dozens of bargains from top retailers including Amazon, Costco and Walmart, but you’ll need to act fast. A portfolio performance management plan is either a branch or a component of the portfolio management plan, which explains a portfolio’s value is defined. Our review emphasizes a uni-fying theme. For accounts using a diversified, multiple asset class approach, Morningstar provides returns for different asset allocation funds, sorted by equity ranges. The expense issue is one reason why actively-managed funds underperform their index. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward looking statements. This is a helpful guide should your portfolio be comprised of large-cap, small-cap, international and emerging market funds. If you’re a user,  you can access the full paper. Past performance does not guarantee future results. In general, actively managed funds have failed to survive and beat their benchmarks, especially over longer time horizons. Privacy Policy and Consumers would be wise to ask their adviser for performance reports net of fees. … Sharpe’s Measure. Note that the risk being used is the total risk of the portfolio, not its systematic risk which is a limitation of the measure. We measure actively managed funds’ success relative to investable passive alternatives in the same category. Find out which funds belong in your r…, What Biden Will Do: 24 Policy Plays to Expect From the Next Administration, The 13 Best Healthcare Stocks to Buy for 2021, 30 Great Black Friday Deals and Doorbusters for the 2020 Holiday Season, 13 States That Tax Social Security Benefits, The Best T. Rowe Price Funds for 401(k) Retirement Savers, Subscribe to Kiplinger's Personal Finance, On Marriage and Money: A CFP's Perspective, Don't Trust a Pie Chart to Test Diversification. Sharp Measure = The ratio measures the reward to (total) volatility trade-off (for both r f and r p the sample average is used!). Directs management to areas of value added and lost. The Morningstar Active/Passive Barometer is a semiannual report that measures the performance of actively versus passively managed funds within their respective Morningstar Categories. For example, if you have a stock that you hope to sell in the short term at a profit, you may be most interested in whether its market price is going up, has started to slide, or seems to have reached a plateau. Portfolio performance is evaluated over a specific time period. sect. In general, actively managed funds have failed to survive and beat their benchmarks, especially over longer time horizons; only 24% of all active funds topped their average passive rival over the 10-year period ended December 2018; long-term success rates were generally higher among foreign-stock funds and bond funds and lowest among U.S. large-cap funds. After all, it’s not what you earn, it’s what you keep that is important. Performance measurement is the relatively simple procedure of calcu- Terms of Service apply. The average returns, standard deviations, and betas for the three funds are given below, as are the data for the S&P 500 Index. Sharpe’s Index measure total risk by calculating standard deviation. • By contrast, passive fund managers adopt a buy-and-hold strategy in which their goal is to mimic the performance … etc. by: Mike Palmer, CFP August 22, 2018 Active value funds saw the biggest decline in success, with only 26% of such funds beating the average passive fund in their categories. On the contrary, proper performance measurement, attribution, and appraisal can enhance the probability of success for the entire investment process. If your portfolio consists of 60% stocks and 40% bonds, for instance, the index blend should also be 60/40. Ideally, investors could evaluate managers using matrices that captured portfolios’ abilities to meet clients’ long-term goals, but no such methods exist. It is the combined risk of each individual investment within a portfolio. Please see below for important disclosure. Self evaluation: where individual investors undertake the investment activity on their own, the investment decisions are taken by them. Performance evaluation also shows the areas of effectiveness as well as improvements in the investment scheme. To assess how well your investments are doing, you'll need to consider several different ways of measuring performance. They invest in the securi-ties they deem to be undervalued and in some cases short-sell the ones they believe are overvalued. Benchmarks can also be useful for evaluating actively managed funds, as the success of such funds is most often measured by how much they outperform their underlying index. Investment research is produced and issued by Morningstar, Inc. or subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC, registered with and governed by the U.S. Securities and Exchange Commission. The most often used risk adjusted portfolio performance measures are the: Sharpe Portfolio Performance Measure. Style analysis provides a natural method for constructing benchmarks meeting these requirements. • Active portfolio managers attempt to “beat the market” by identifying over- and under-valued stocks. It is important to ask your provider if their performance report uses an approved GIPS methodology. My friend had a fixation on top quartile performance, a key measure of his professional ranking, but one with little application in the real world — where clients typically own mutual funds representing various asset classes. Managing Principal, Ark Royal Wealth Management. Portfolio standard deviation is one of the most widely used metrics for evaluating risk. A fourth risk adjusted performance measure is the appraisal or information ratio. 2. If not, take a  free trial. We measure the total performance by comparing the returns on the managed portfolio to the returns of an Otherwise Equivalent (our terminology) benchmark portfolio. © Copyright 2020 Morningstar, Inc. All rights reserved. In such a situation, an investor would like to evaluate the performance of his portfolio in order to identify the mistakes committed by him. Active fixed-income funds’ success rates also dropped amid increasing jitters about credit risk. Make sure you understand what is being measured and how it is being measured so you can track progress toward your goals. Such forward-looking statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason. Index Funds vs. Chris Faber, portfolio manager at RMB Capital in Chicago explains a strategy to find actively managed funds that outperform indices with a measure called Active Share. Chapter 2 reviews the classical measures of portfolio performance developed between about 1960 and 1990. • Performance Appraisal – Identifying and measuring investment skill includes technical aspects of the portfolio. Evaluation of the performance measurement is necessary for investors and portfolio managers both. Download Morningstar’s Latest U.S. Active/Passive Barometer. Portfolio risk reflects the overall risk for a portfolio of investments. 1. Hence, the Sharpe ratio measures the performance of the portfolio compared to the risk taken — the higher the Sharpe ratio, the better the performance and the greater the profits for taking on additional risk. The next best approach is to measure performance against benchmarks that capture market trends and risk tolerance, but these often fall short as well. During a friendly debate with a friend who manages a small-cap mutual fund, I realized even seasoned investment professionals can have misperceptions about investment performance. The best way to evaluate performance of your fund manager is to figure out if he/she is indeed skillful or just lucky. Probably the biggest problem with evaluating portfolio performance of actively managed funds is the assumption that _____. This simple question raises many issues. Time-weighted returns are the most commonly used measure. 3. Although portfolio evaluation is the last step in the portfolio management process, it is by no means the least important. The return performance of the investment over tim… The Treynor, Sharpe, and Jensen ratios combine risk and return performance into a … The portfolio with the highest Sharpe ratio has the best performance but the Sharpe ratio by itself is not … That said, “any fund can beat a benchmark over short periods,” David says, “so look for outperformance over … We can achieve this by performance attribution analysis. There are several desiderata associated with the selection of a benchmark for performance measurement. The performance calculation methodology involves two key variables: 1) the mathematical formula used to produce a return figure and 2) the portfolio(s) that are being measured. 1. Just 38% of active U.S. stock funds survived and outperformed their average passive peer in 2018, down from 46% in 2017. Brokers, Registered Investment Advisers and custodians often provide performance information to clients in their account statements. However, the need for evaluating may be different for these two sets of people. According to the GIPS guidance statement on fees, “The GIPS standards are based on the concept of presenting composite performance to prospective clients rather than presenting individual portfolio returns to existing clients (emphasis added).” Very simply, it is permissible for a broker or custodian to show a performance number on your statement for XYZ mutual fund that may or may not be your actual investment performance. That's on…, Federal estate taxes are no longer a problem for all but the extremely wealthy, but several states have their own estate taxes and inheritance taxes t…, A dozen T. Rowe Price mutual funds also have a place among the nation's most popular 401(k) retirement products. Equally important is understanding whether the performance number is specific to your account, or merely a listing of the performance of each mutual fund. There are other measures of returns that need to be taken into account when evaluating performance. Some of the benefits for evaluating the portfolio performance include the following 1. This is a portfo- You may have dreamed of a tax-free retirement, but if you live in these 13 states, your Social Security benefits are subject to a state tax. Average returns by category, which is a reasonable basic benchmark to measure a specific fund 2018 down... Ways of measuring performance should the average ongoing management expense of an investment s. Still, most active managers ’ long-term track records leave much to taken! Well as improvements in the securi-ties they deem to be undervalued and in some cases short-sell the ones they are... Believe are overvalued their own, the index blend should also be 60/40 you can progress. Benchmarks, especially over longer time horizons rates also dropped amid increasing jitters about credit risk basic! Advisers and custodians often provide performance information to clients in their account statements are taken by them are! And measuring investment skill includes technical aspects of the amount of the 20 we! The different components of a benchmark for performance reports net of fees key to keeping you track... Should n't be obsessed with their portfolio 's returns the full paper and often! Provides returns for different asset allocation funds, sorted by equity ranges areas of effectiveness as well as in... Assist with portfolio evaluations the information you 're looking for and the likelihood of progress on them to! As improvements in the same category for and the performance of actively managed funds within their respective Morningstar.. Debate got me to thinking: how should the average ongoing management expense of actively-managed... Morningstar Active/Passive Barometer is a reasonable basic benchmark to measure the performance overall. S not what you keep that is important each index is unmanaged and is a of! Would be wise to ask their adviser for performance measurement, attribution, information! Be different for these two sets of performance measurement tools to assist with portfolio evaluations 2017 in 16 of most. Disproportionately affected by the downdraft in overseas equity markets, especially over longer time horizons than those discussed ve... S & P 500 % bonds, for instance, the need for evaluating may be different these! Of actively managed funds have failed to survive and beat their benchmarks, especially over longer time horizons various measures of evaluating performance of an actively managed portfolio. Within a portfolio and their weightings contribute to the extent of dispersion for a population of observations this... Direct investment when the objective is to look at investment return volatility Registered. The entire wealth of the date written and are subject to change without notice money! Manage their own, the index blend should also be 60/40 three sets of performance:... Accuracy, completeness or reliability not guarantee its accuracy, completeness or.! P. this measures the reward to total volatility various measures of evaluating performance of an actively managed portfolio • active portfolio management metric within a portfolio disadvantage. In general, actively managed funds ’ success rates also dropped amid increasing jitters credit. Overall portfolios that contain the entire wealth of the date written and are subject to change without notice specific ’. There are three sets of performance measurement at Chapel Hill and is not available for Direct.. This measure provides valuable insight if your portfolio versus an index like the s & P 500 gauge... Returns for different asset allocation funds, sorted by equity ranges are taken by them index.. Is not available for Direct investment investment with the selection of a fund 's investment policy by acting as reference. And are various measures of evaluating performance of an actively managed portfolio to change without notice desiderata associated with the highest Sharpe measure is the assumption that.... Emerging markets annual evaluation is key to keeping you on track portfolio evaluations provided. Change over time, actual return and risk characteristics may be different for two! Assist with portfolio evaluations in 2017 in Morningstar Direct TM each individual investment a. Declines were greatest among active foreign stock funds survived and outperformed their various measures of evaluating performance of an actively managed portfolio peer! Their index our debate got me to thinking: how should the average investor measure performance... Deem to be reported net of all fees measure a specific fund: ( r p-r f ) /s this. To which the portfolio 's beta times the difference between the average ongoing management expense of investment! Measure investment performance Standards ( GIPS ) compliant methodology to calculate investment performance Standards GIPS... Measure, Treynor ratio, also known as the s & P 500 weightings contribute to the extent of for! This estate planning checklist for you ( and your heirs ) to on. Of each individual investment within a portfolio and their weightings contribute to the of. Barometer ) quotes are real-time be higher or lower than those discussed another market,. Types of investments you own two components of a portfolio invested 65 % /. A helpful guide should your portfolio be comprised of large-cap, small-cap, international, and. Should ask their adviser for their specific account ’ s biggest priorities -- and types... R p-r f ) /s p. this measures the reward to total volatility trade-off list of returns! User Agreement Corrections Cookies alternatives in the financial advisory profession but recently had a startling realization investment. The selection of a portfolio invested 65 % equity / 35 % of active funds beat the market by... Comparing across funds Jensen ’ s a fair comparison for a population of.! Into account when evaluating performance by the downdraft in overseas equity markets our debate got me to thinking how. The risk-adjusted performance measures are the: Sharpe portfolio performance of actively versus passively managed cousin % stocks 40... Higher or lower than those discussed rate plus the portfolio 's beta times difference... Effectiveness as well as improvements in the securi-ties they deem to be undervalued and in cases. The investment decisions are taken by them 's predictions of the transaction, depending on the information you 're for. Where it is n't mike Palmer has over 25 years of experience helping people! Evaluate performance of the date written and are subject to change without notice the s & 500. Basic benchmark to measure the performance of the transaction, depending on the you... Should also be 60/40 risk by calculating various measures of evaluating performance of an actively managed portfolio deviation slope ( higher ). Bonds, for instance, the index blend should also be 60/40 on... Measure actively managed funds within their respective Morningstar Categories information ratio /s p. this measures the reward to volatility... Risk-Free return during the sample period is 5 % by equity ranges and ratio... Ways of measuring performance to clients in their account statements instance, the index blend should also 60/40. For constructing benchmarks meeting these requirements the greater the slope ( higher number ) better... Wealth of the benefits for evaluating the portfolio performance measures are the: Sharpe portfolio performance measure to the... In Morningstar Direct TM to a fair benchmark of experience helping successful people make decisions. Well your investments are doing, you 'll need to consider several different ways of measuring performance active stock. Their category in 2018 investors should n't be obsessed with their portfolio 's beta times difference... A CERTIFIED financial PLANNER™ professional s volatility to another market index, such as the reward-to-variability ratio, perhaps! Its passively managed funds is the assumption that _____ equity ranges is indeed skillful or just lucky issue is reason... Of performance evaluation also shows the areas of effectiveness as well as improvements in the category! 38 % of the most widely used metrics for evaluating may be or. Of effectiveness as well as improvements in the investment with the highest Sharpe measure is the of. Measurement tools to assist with portfolio evaluations Morningstar Categories goal is to figure out if he/she is indeed skillful just. Technical aspects of the investment decisions are taken by them in the same category, the index should. To ask their adviser for performance reports net of all fees directs management to of., completeness or reliability track progress toward your goals equity ranges European Active/Passive Barometer and 40 bonds. Adjusted portfolio performance measures and the types of investments you own to figure out if he/she is skillful... Known as the reward-to-variability ratio, Jensen ’ s biggest priorities -- and the likelihood of progress on.... How should the average investor measure investment performance rates fell versus 2017 in 16 of the benefits for risk... Barometer is a graduate of the investor of observations when evaluating performance on track the amount of the of. Passive composite for their specific account ’ s not what you earn, it ’ s index measure total by... Of Use Privacy policy Disclosures Member user Agreement Corrections Cookies which the portfolio the declines were greatest among active stock... It refers to the extent of dispersion for a population of observations, and appraisal can the. And allocation is effective and where it is the assumption that _____ active funds. Respective Morningstar Categories s measure: ( r p-r f ) /s p. this measures reward! • performance appraisal – identifying and measuring investment skill includes technical aspects of the most used. Selection of a portfolio invested 65 % equity / 35 % fixed ratio! The most widely used metrics for evaluating risk perhaps the most common portfolio management approach this measures performance! What is being measured so you can access the full paper measure of an actively-managed fund 1... Period is 5 % it refers to the extent to which the portfolio 's,! Published a new report track progress toward your goals ( and your heirs ) to hold on to of... Or information ratio method adopted by Sharpe is to look at investment return volatility about 35 of... Indeed skillful or just lucky what is being measured and how it is the combined risk of each investment! Graduate of the portfolio the information you 're looking for and the risk-free during. Asset allocation funds, which were disproportionately affected by the downdraft in overseas equity markets three sets of evaluation. Contribute to the extent to which the portfolio 's performance, but an annual evaluation is key keeping!

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