Investment Management Flashcards
Why passive portfolio will not provide exact returns in line with the benchmark
Management fees
Trading and transaction costs
Re-investment of dividends may differ between index and portfolio
Rebalancing takes time
Manager have poor tracking skills
Using approximate tracking methods
Pay tax on crystallized capital gains and derivatives
MWRR and TWRR
MWRR factors in all cash flows, including cash flows and withdrawals
Formula will place a greater weight on performance in periods where the account size is the highest
If investors deposits large funds at the beginning of a quarter of under-performance, then MWRR would produce a lower return even if performance in the future is good
Investors deposits and withdrawals are usually beyond a manager’s control
TWRR is defined as the compound growth rate of 1 over there period being measured
TWRR isolates the investment action/decisions of manager and does not reward/penalize deposit/withdrawal
Tactical asset allocation and factors to consider
A departure from the long-term strategic benchmark position in an attempt to maximize return
The expected extra returns to be made relative to the additional risk
Constraints on the changes that can be made to the portfolio
Expenses of making the switch
Problems of switching a large portfolio of assets
Expertise the investment managers needed
Availability of suitable derivatives
Define active management
Manager has few restrictions on the choice of investments, perhaps just a broad benchmark of asset classes.
This enables the manager to make judgements regarding the future performance of investments, both in the long term and the short term
Define passive management
Holding of assets that closely reflects those underlying a certain index or specific benchmark.
The manager has little freedom to choose investments
Why choose active management and why not
Generally expected to produce greater returns due to freedom of judgement
Achieve higher returns by identifying:
under- or over-priced sectors, sector selection profit
under- or over-priced stocks - stock selection profits
Not possible to produce greater returns if market is efficient
Higher returns offset by:
extra costs involved in more regular transactions
risk of manager’s judgement is wrong and return is lower
manager charge higher fees for additional research with active manage
additional governance required
tax liabilities may be crystallised when switching portfolios
Define strategic risk
Risk of poor performance of the strategic benchmark relative to the value of liabilities
Define active risk
Risk taken when the investment manager have freedom over stock selections, and use their skills and research to maximize the return within their given guidelines.
Typically relates to any deviation from the benchmark that was given
Define risk budgeting
process of establishing how much risk should be taken and where is it most efficient to take the risk in order to maximise return
Discuss the risk budgeting process
has two parts:
decideing how to allocate the maximum permitted overall
risk between total fund active risk and strategic risk
allocating the total fund active risk budget across the
component portfolio
key focus is the risk tolerence - systematic risk prepared to take on to enhance long-term returns
key question on active risk is whether it is believed that active management would generate positive excess returns
risk budgeting is an investment style where asset allocations are based on asset’s risk contribution to the portfolio as well as on the asset’s expected return
Key factors that influence the balance of objective
level of free assets
level of diversification
Define SYSTEM T and what is that used for
Security
Yield
Spread
Term
Expenses
Marketability
Tax
Define Structural risk
when the aggregate of portfolio benchmark differs from the strategic benchmark
outline constraints that could be placed on investment managers to limit amount of active risk
given a range of allowable allocations per asset class
restrictions on currency mismatches
tracking error limits for equities
duration limits and credit limits for bonds
restrictions on assets not included in the appropriate index
