Week 11 Flashcards
Calculate what percentage of each of these companies that the manager would need to purchase to achieve a standard 4% position at 5 levels of funds under management (FUM): $250 million, $500 million, $1 billion, $2 billion and $4 billion.
Capacity is obviously a significant consideration for this manager and investors in this fund. The manager may have difficulty investing in companies towards the lowest quarter of the investment universe (i.e. stocks ranked 150-200) once FUM gets much above (say) $1 billion, as they would need to purchase over 5% of these companies to establish a standard 4% position.
Similar problems would arise if FUM rises to over $2 billion for companies around the middle the universe (i.e. stocks ranked near 100). This fund may have a capacity of something like $1-$2 billion.
by restraining FUM, the manager would be able to
effectively implement their current investment process, and avoid any fade in returns
Effects as FUM increase:
increasing need
(b) There would be an increasing need to be sure of companies purchased, as bad positions may become very difficult to reverse at reasonable prices.
(c) A longer investment time horizon may become necessary.
(d) Increasingly the manager would be forced to hold either: (a) more stocks, or (b) larger stocks. This could dilute the effectiveness of the manager’s skill.
Effects as FUM increase:
trade
) Ability to trade small-medium sized companies quickly without moving the market is much diminished. Manager would face an increasingly difficult trade-off between potential market impact from trading, and the speed at which a position can be accumulated or exited at attractive prices.
Do these processes rely on high breath or high skill for success?
Private equity fund
More skill, but some breadth (number of companies held)
Do these processes rely on high breath or high skill for success?
Fund of hedge funds
More breadth, but some skill (selecting funds)
Do these processes rely on high breath or high skill for success?
Fixed income manager that forms their portfolio around a view on interest rates
skill
Do these processes rely on high breath or high skill for success?
Quant equity fund that holds 50-60 stocks which are turned over often
Breadth
Do these processes rely on high breath or high skill for success?
Stock picker with a high tracking error of 7%-10% that holds 10-15 stocks
Skill (mainly – even though stock picker, TE and # stocks implies very concentrated portfolio)
Do these processes rely on high breath or high skill for success?
(a) Asset allocator that engages in strategic tilting or dynamic strategic asset allocation (DSAA), i.e. occasional shifts away from SAA when markets appear to be at some extreme
Skill (almost exclusively)
in what way might an existing capital gains tax liability (or asset) influence the decision to trade?
An existing CGT liability (asset) means that the investor requires a higher (lower) rate of return from a new asset in order to justify trading.
This is because paying CGT decreases the amount of funds invested, and therefore the new stock needs to work harder to make up the gap.
Alternatively, getting a tax deduction for capital losses increases the amount of funds invested, and therefore the stock needs to work less hard to make up the gap.
general guidelines for how a portfolio manager could manage their portfolio to maximize after-tax value for their investors?
Know your tax parcels
- Realize losses (called ‘tax loss harvesting’)
- Before selling a stock with a large CGT liability, ask whether the replacement asset generates a sufficient expected return to justify the transaction.
- Be aware of differences between short-term and long-term CGT rates.
how inflation might influence how portfolios are managed in a tax-effective manner? (Hint: Think about how inflation interacts with returns and hence CGT over the long run.
Inflation generally raises the level of nominal returns over the long run
This can have the effect of reducing the justifiable level of turnover in portfolios that are managed to minimize tax, as tax liabilities become larger as they build up over time, i.e. the hurdle to justify switching will tend to increase.
Significance of tax to portfolio outcomes
When both the existing and new stock have the same E[R] of 10.0%, the value difference at the end of year 10 is -6.8% for a cost base of $0.50 and +11.7% for a cost base of $2.00. These are economically meaningful differences in value, equating to differences in annualized return of about -0.7% and +1.1%.
ignoring tax may be quite costly for accumulated portfolio value and after-tax returns over time.
past performance is a ___ basis for assessing investment skill.
considered in isolation, past performance is a poor basis for assessing investment skill.
b.c there is a high degree of randomness in relative investment returns and that to be statistically signi cant a performance record should be intact for nearly 15 years; differentiate luck from skill
it is possible that a skilled manager will generate poor returns for an uncomfortably long time before his skill again manifests itself.
Explicit determination of investment skill in an equity fund manager is complicated.
should focus on
A focus on the long term is particularly important, as some asset managers appear to rely on the randomness of returns in markets to produce a positive short-term track record, which is then used to market products to advisors and clients who are attracted by short-term performance.
An investment philosophy is important
An investment philosophy is important because no one knows what a business will earn or what equity risk premium should be applied in the future.
Consequently, investment managers need
a relatively constant framework of beliefs to guide them in the formulation and execution of their process.
The role of investment philosophy
manager’s beliefs about what creates investment opportunities, how a process can be constructed which enables the manager to capture sustainably such opportunities, what competitive advantage the manager may have and how this process can be expected to evolve.
Assessing whether the portfolio will deliver the expected alpha
equity managers
starts with a detailed examination of the investments within the portfolio for any obvious inconsistencies with the process.
If there are investments which appear to contradict the process then these may be prioritisedfor discussion.
Examining such exceptions deepens our understanding of the process and the manager.
Alternatively, poorly performing investments may be selected on the basis that we are likely to learn more from a manager’s mistakes than from his successes.
Our sole objective in discussing investments is to
ather evidence to support an opinion of the manager’s investment skill and ability to generate alpha
Critics of multi-manager investing sometimes assert that combining multiple investment managers
results in lower returns than investing with individual managers. They ascribe this to ‘over-diversification’
combining managers with positive alpha
reduces tracking error (assuming the managers are not perfectly correlated), but does not, of itself, reduce returns
. Since each manager is expected to outperform the market, so should any combination of these managers. Adding more managers, as long as they also outperform the market, does not change this result.
The lower tracking error we observe in multi-manager portfolios is due to
reduced style and manager risk. Lower tracking error is attractive to investors since it results in more certain performance outcomes.
Benefits of multi-managers
these manager mixes were derived randomly; skilful combination of the managers would result in even greater diversification benefits
for Single manager there is a positive relationship
multi-managers
between alpha and tracking error
Again, while excess returns remain unchanged when combining managers, tracking error falls dramatically.
Why do people think that multi-managers lead to lower alpha
but
due to lower active bets
active bets are not the only factor that drive alpha. alpha is generated not only by the size of active bets but how many of these bets turn out to be corret (manager skill)
. It is certainly true that for a given level of skill, decreasing active bets will
reduce alpha
when managers with positive alpha are combined.
is that the level of ‘skill’ that increases
each manager brings some unique skill (however small) to the portfolio
less active bets but are more likely to be accurate
So the decline in alpha one might expect from smaller active bets is offset by an increase in the success ratio.
There are two key factors that may lead to higher costs for multi-managers
■ Additional custody and administration costs for each manager’s mandate.
■ Higher manager fees
what offsets higher management fees from multi-managers
weighed against the benefits of lower tracking error and improved performance outcomes.
In trying to identify outperforming managers a multi-manager should look at net performance; that is, performance after all costs have been paid.
combinations of high risk managers can
result in significant outperformance, with only moderate tracking error.
Such a multi-manager portfolio, comprised as it is of high risk strategies, may have higher costs than a low risk single manager, but the alpha potential is far greater and so should more than compensate for the added costs
The investment process
Review
Review of whole investment process: refine investment philosophy. Refine the signal creation or signal acpture or improve efficiency in implementation process. How portfolio managers performance is going to be evaluated?
Attribute the excess return over the benchmark as driven by skill or luck.
Feedback process
Implementation
buying or selling a particular stock. Will that transaction move the market price?
not relevant for individual, but for institutional investors esp within a very small equity market in austraia, the fund managers need to consider whether buy or sell orders will move the market price
They have to evaluate the trade of of potential benefits and costs of doing the trade then ask the broker to buy or sell on their behalf
Signal capture:
Everyday new info comes into market of a particular company, asset so signal capture process will calculate.
Try to create summary statistics or ranking info of all of listed au companies.
Through this process, we may distinguish firms that are more likely to be undervalued that of good quality from the rest of the firm. These firms will become candidate to be included in portfolio.
Signal creation:
Dfnie kind of measures we will create signal.
E.g. selecting value au stocks, going to use the signal of value measures e.g. PE ratio or other alternative measures of value
These bench of measures help us to create signal. During process, set a hurdle so that only stocks that exceed this hurdle may become cadidate to be icluded in portfolio.
Investment philosophy
ideas, concepts e.g. actively select undervalued stocks on a group of measures and tries to achieve absolute return of ceretain perentage over investment horizon
Investment style
