15. Portfolio management Flashcards
(112 cards)
1
Q
Ex-ante risk and return measures
A
Calculated before the investing period gets underway
2
Q
Ex-post measures of risk and reward
A
Calculated as time unfolds, actual values after the investment event
3
Q
Ex-post standard deviation
A
A measure of the dispersion of returns around the average return over a given period
4
Q
3 criticisms of SD
A
- based on past, future may be different
- measures upside and downside movements, concern on investments more on downside
- assumes upside equally likely as downside
- volatility generally not a complete measure of risk, e.g. inflation risk
5
Q
3 alternative risk measures to SD
A
- Semi-variance: only measures returns that fall below certain value
- Shortfall probability: measures chance, not value
- Expected shortfall: measure of expected loss at a given probability level
6
Q
VaR analysis
A
Used to estimate the capital loss on a portfolio or an individual asset over a given time period that will be exceeded with a given frequency or probability
7
Q
3 features of VaR
A
- Time period
- Probability level (confidence)
- Loss amount or %
8
Q
Historical return approach
A
Reorganises past returns from high to low and assumes history will repeat itself
9
Q
3 ways to calibrate VaR
A
- Historical return approach
- Variance- co-variance method
- Monte Carlo approach
10
Q
Variance- co-variance method
A
Assumes daily returns follow a normal (or similar) distribution
11
Q
Problem with variance-co-variance method
A
Relies on many popular assumptions about the shape of relative frequency of losses that are unrealistic in practice
12
Q
Monte Carlo approach
A
Mathematical model for stock price returns, running multiple hypothetical trials of the model
13
Q
‘Fat tails’ problem
A
In real world, extreme positive and negative returns occur far more often than predicted by a normal distribution
14
Q
Monthly SD of returns =
A
SD of daily returns x √T
15
Q
VaR concept criticised since financial crisis because?
Consequently?
A
Many investment losses were far worse than ‘predicted’.
Consequently many VaR models have since been revisited to allow for a higher probability of extreme losses.
16
Q
Stochastic modelling
A
A form of financial modelling of future outcomes based on ranges of values (rather than single estimates) where the value of each unknown variable, such as investment returns and inflation, is based on a statistical likelihood.
17
Q
Deterministic model
A
Output of model is fully determined by the parameter values and the initial conditions and hence, any projections or forecasts can be made with certainty.
18
Q
Stochastic models can project ___ as well as risk.
A
future asset or portfolio returns
19
Q
Drawdown measures what 2 things?
A
Measures max amount an investor could have lost since the investment was at its highest price ; or
Size of loss an investor would have incurred by investing with a manager in the past
20
Q
Advantage of drawdown
A
It refers to an empirical reality and is therefore less abstract than concepts such as volatility.
21
Q
Limitations of drawdown
A
- longer the time series, generally the greater the drawdown (despite longevity implying robustness, experience)
- max drawdown is a single number and will therefore have a large and uncertain error distribution
22
Q
Tracking error
A
The difference between a portfolio’s return and the benchmark or index it was meant to follow or beat
23
Q
2 ways to measure tracking error
A
- Portfolio returns - benchmark returns
- √(Rp - Rbm)^2 / (N-1)
24
Q
Name 3 factors which determine a portfolio’s tracking error
A
- degree to which portfolio & benchmark have securities in common
- diffs in mkt cap, timing, inv style
- diffs in asset weighings
- mgt fees, custodial fees, brokerage costs
- BM volatility
- portfolio beta
25
Low (high) tracking error means
portfolio is closely following BM (opposite)
26
When a portfolio outperforms the BM, tracking error may suggest what?
Fund manager took on greater risk
27
Typical technique to illustrate risks taken by find manager in managing a portfolio over a specific period
Plot the realized return and SD on fund, plus the realized return and SD of any relevant BM portfolio
28
A portfolio is said to dominate another if: [2]
- same risk, higher return
- same return, lower risk
29
Relative weight of an individual security in a portfolio =
Value of that security
/
Monetary value of portfolio itself
30
Active share measure
Indication of what?
How different the components of a fund are from the index it tracks.
Is an indication of how 'active' fund is relative to index weights.
31
Active share measure =
Abs (weights in portfolio - weights in BM)
/
2
32
Active share measure of 0% for a benchmark would be an ___, whereas 100% would indicate ___.
- index-tracking fund
- no overlap with BM
33
'Closet tracker'?
Active share measure general range?
- Fund which charges higher fees than explicit tracking funds.
- Between 20% to 60%
34
Unsystematic risk
Risk specific to that asset
Aka specific risk, company risk
35
Systematic risk
Whole of market risk, and wider
36
Total risk =
Systematic + unsystematic risk
37
2 ways to reduce portfolio risk
1. Reduce unsystematic risk so only systematic risk remains (well-diversified portfolio)
2. Add assets to portfolio so systematic risks start to offset each other
38
Correlation coefficient
How closely returns on target asset are related to returns of existing portfolio
39
Correlation coefficient range
- -1, perfectly negative correlation: returns always move in opposite direction at same time and to same extent (changes don't have to be same amount)
- +1, perfectly positive correlation: returns always move in same direction, at same time to same extent
- 0, no relationship i.e. no systematic risks common to 2 stocks
40
Correlation =
Covariance (x, y)
/
SDx x SDy
41
Correlation shortfalls [2]
- correlations change over time
- linear association, more complicated non-linear in real life
- correlation doesn't imply causation
42
During times of financial stress, all assets can do what?
Covary together where correlations all tend towards 1
43
CAPM assumptions [4]
- financial mkts perfectly competitive, free of taxation and transaction costs
- investors have same expectations about returns and SDs
- investors can borrow and lend at same RF rate of interest
- investors try to maximize their returns while simultaneously trying to minimize risk
44
SML (security mkt line) mkt-risk premium
Amount of return expected above return for RF asset that investors require in compensation for taking on mkt risk
45
CAPM beta measures?
Systematic risk of security relative to systematic risk of mkt portfolio (or index)
46
Beta =
Covariance (Rp,Rm)
/
Variance (Rm)
47
Beta range [3]
- 1: risky as mkt
- <1: less risky than mkt
- >1: more risky than mkt
48
Variance of portfolio return =
Beta x variance on return of mkt + variance of unsystematic diversifiable part of portfolio
49
2 limitations of CAPM
1. Knowledge of a company's beta is not a useful predictor of returns relative to mkt
2. Assumptions such as all agents have same probability distribution of future returns unrealistic in practice
50
APT, the following macro-economic factors as being important in explaining stock returns.
Surprises in: [3]
- inflation
- GNP
- investor confidence
- shifts in yield curve
51
APT or multi-factor models of equity returns
Expected return of a financial asset and be modelled as a linear function of various macro-economic factors or theoretical mkt indices.
Each factor has a factor-specific beta coefficient.a
52
A factor
An attribute of a security which has been identified over time as a persistent driver of returns
53
Factor investing
Creating a portfolio which is particularly sensitive to a factor you feel strongly about the outlook of that factor, but which is neutral to a factor which you are unsure of its direction.
54
Name 4 popular single factors for investors building portfolios.
1. low volatility
2. momentum
3. value
4. quality
5. high divi yield
6. size
55
Smart beta investing
Rules-based factor investing through ETFs, combing active & passive strategy
56
EMH
Idea that security prices instantly reflect all available info, therefore mkt price of securities will always equal their FV
57
How do security prices move under EMH?
Unpredictably and randomly as any info that could be used to predict security prices is already reflected in the prices, and prices only change in response to new info which is unpredictable.
58
3 versions of EMH
1. **Weak form**: prices already reflect past info
2. **Semi-strong form**: all publicly available info about a firm e.g annual rpts already contained in stock price
3. **Strong form**: all info, inc. that only available to company insiders, is reflected
59
EMH, conditions for existence of efficient mkt
- large no. of rational, profit-maximising investors, securities valued rationally
- any non-rational behaviour is random and cancels itself out
- info is free & widely available, arbitrageurs act to eliminate any mispricing
60
Research has found that firms with a ___ mkt cap tend to have returns ___ than would be predicted by their betas.
- smaller
- larger
61
4 beliefs of std finance (behavioural finance alt view)
1. investors rational (not)
2. mkts are efficient (not, even if hard to beat)
3. portfolios designed per mean-variance portfolio theory (rules of behavioural theory)
4. expected returns depend on risk alone (more)
62
Framing bias
Decisions influenced by how choices are framed.
63
Memory bias
Too much weight given to recent experience.
64
Confirmation bias
More open to info when confirms pre-existing views.
65
Conservatism bias
Too slow in updating beliefs in response to new evidence.
66
Endowment effect
Higher value placed on asset that they own than if they didn't own it.
67
Loss aversion / prospect theory
Losses feel worse than gains feel good, leading to selling winning stocks too soon & holding losing stocks too long).
68
Anchoring
Too much emphasis placed on irrelevant facts e.g. prev stock price
69
Mental accounting
Segregating certain decisions and not seeing full picture
70
Criticism of behavioural finance
Little predictive power and difficult to test
71
Reason for surge in development of behavioural finance
Attempts to rationalise existence of anomalies
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Financial amnesia
Acting in a way where lessons of financial mkt history have been forgotten.
73
What is a condition for bubbles occurring?
Financial valuations becoming removed from fundamentals.
74
Estimating FV, 3 levels uses?
- Level 1: quoted input prices form active mkts
- Level 2: prices from similar mkts but not identical assets
- Level 3: 'unobservable' indirect inputs e.g. assumptions by mkt participants
75
Threshold capacity
Level of AUM that allows strategy to achieve its stated inv returns
76
Wealth maximising capacity
Level of AUM that maximises level of wealth created
77
Terminal capacity
Level of AUM that reduces the alpha, net of transaction costs, to zero
78
2 approaches to assessing inv cacacityq
1. Estimating capacity by looking at impact of trading
2. Estimating capacity by looking at impact of accumulating large positions
79
Tactical asset allocations
Where investment manager has strong views on ST performance for diff asset classes and deviates slightly from strategic portfolio weights.
80
'Bottom-up' portfolio formation
'Top-down' portfolio formation
- each individual security considered on merits and portfolio built from specific stocks
- wide asset classes initially specified with LT strategic portfolio proportions, giving way to ST tactical deviations
81
Success of managing a passive index tracking fund 2 determinants
1. Cost of managing fund
2. Tracking error
82
Biggest issue with passive tracking techniques
Bear mkt - then passively tracking a flat or falling mkt
83
Active fund mgt
Fund managers looking for over or under-priced securities and adjusting their portfolios to take adv of these 'mispriced' assets
84
Active fund mgt biggest challenge
The more funds with mispriced assets invested in, greater the specific risk.
85
Combining passive with active fund mgt, slightly changing mix of assets passively tracking index is known as what?
Portfolio tilting
86
Mixed investment 0-35% shares
- Equities
- FI or cash
- Established mkt currencies
- 0-35%
- Min 45%
- Min 80%
87
Mixed investment 20-60% shares
- Equities
- FI or cash
- Established mkt currencies
- 20-60%
- Min 30%
- Min 60%
88
Mixed investment 40-85% shares
- Equities
- FI or cash
- Established mkt currencies
- 40-85%
- No min
- Min 50%
89
Bond portfolios, cash matching
Purchasing bonds so cash recv from coupons & principal at each period exactly matches cash outflows
aka 'dedicated portfolios'
90
Bond portfolios, immunisation
Choose bond portfolio with same duration ('average maturity' of bond) as liability it is intended to meet so portfolio is then 'immunised' from changes in interest rates
91
If int rates rise, immunisation involves gain from reinvested income offsetting fall in price of bond, as int rates rise. (opposite if int rates fall)
2 risks offsetting are?
- reinvestment risk
- price risk
92
Immunisation assumptions [2]
- All promised cash payments are realised
- No default or early redemption of bonds prior to maturity
93
Bullet (focused) portfolio
Portfolio of bonds formed with individual durations similar to desired duration
94
Barbell portfolio
Portfolio of bonds with much smaller & much larger durations than target
95
Advantage of barbell strategy
Can select from a much greater range of bonds
96
As time passes and due to changes, bond portfolios may no longer be immunised.
Fund manager options, pros & cons [2]
- rebalance frequently to reduce duration mismatch, high transaction costs
- rebalance infrequently, increase duration mismatch but reduce portfolio transaction costs
97
Liability driven investment (LDI)
Seeking to match, wholly or in part, liabilities of a financial institution or an individual with its assets., whilst managing funding level risk.
98
LDI often uses what to hedge out risks? [2]
Swaps & derivatives
99
Formulating LDI strategy [4]
1. Cash flow FCs of future funding needs
2. Determine acceptable risk
3. Chance of active mgt outperformance
4. Implement LDI strategy
100
Swap spread
Most LDI investors hold swaps & high-quality bonds to hedge int rate & inflation risk.
Swap spread is variation in difference between govt bond yields & swap rates
101
Causes of swap spreads [2]
1. Credit risk of govt bonds
2. Financing risk and shrinking bank BSs
3. Monetary and fiscal policies can lead to changes in demand for bonds
102
SRI introduces an ethical or values-based dimension to investing, often involving ___.
negative screening
103
Shareholder advocacy and engagement
Where institutional investors seek to enact constructive change in investee companies by encouraging wider corporate responsibility or sustainable practises through engagement and thoughtful proxy voting.
104
ESG takes agnostic approach to ___ unless it causes reputational damage or is eroding social license to operate.
ethics
105
ESG examples
- E
- S
- G
- climate change, hazardous waste
- social concerns e.g. diversity, human rights
- governance issues e.g. mgt structure, director pay
106
Purpose of Principles for Responsible Investing (PRI) 6 principles
To encourage firms to incorporate ESG issues into their investment & business decisions
107
ESG investing, demand side factors [3]
- environmental and societal issues increasingly coming to attention of public
- increasing evidence that responsible investing doesn't lead to poor inv returns
- more responsible investment vehicles
108
ESG investing, supply side factors [3]
- increasing disclosure req's for companies - more transparency
- reputational risk
- financial risk
109
Studies showing companies with favourable ESG characteristics have tended to outperform those with negative ones, particularly driven by ___ metrics.
governance
110
Challenges of including ESG into investment analysis
1. ESG factor info - hard to obtain consistent comparable, audited ESG info.
2. Companies disclosing reality of their ESG position?
111
Social impact investing
Provision of finance to org's addressing social needs with expectation of a measurable social, and financial, return.
112
3 key characteristics of impact investing
1. intentionality of investor to generate S and/or E impact through inv's
2. return expectations
3. impact measurement - investor committed to measure & report S & E performance & progress of underlying investments, helping transparency & accountability
