Chapter 17 Flashcards
(14 cards)
Define an active investment management
The 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 future performance of individual investments, both in long- and short-term.
Define a passive investment management
Holding of assets that closely reflect those underlying a certain index or specific benchmark. The manager has little freedom to choose investments
Define risk budgeting
Process of establishing how much risk should be taken and where it is most efficient to take the risk in order to maximise return
Why actively invest?
You would actively invest bc you believe you can outperform passive management benchmark by either increasing returns or lowering risk
It could achieve higher returns by identifying:
· Mis-priced sectors -> sector selection profits
· Mis-priced stocks -> stock selection profits
Why not actively invest?
Extra costs involved in more regular transactions, particularly when attempting to make short-term gains
· Risk that the manager’s judgement is wrong Þ lower returns
It also assumes markets are efficient
Why not passively invest ?
Index may perform poorly
· There may be tracking errors
Why testing active fund managers by comparing fund performance of against a number of index-trackers may not be a true reflection of performance ?
o There will be a survivorship issue (poor performing active funds cease to gain new business and are wound up, so there’s bias towards those that perform adequately)
o Past performance not always a good guide on future performance
o Objectives of active and passive managers may differ
o Amount of risk may be higher in active manager’s pfs
o Different constraints on actives that affect their performance
Define tactical asset allocation
Departure from benchmark position and hence conflicts with the minimisation of risk, in pursuit of higher returns. To take advantage of temporary mis-pricings
Factors to consider before making tactical asset switch
A – Additional returns vs. additional risk
C – Constraints on changes to the portfolio
C – Costs or expenses of switching
E – Execution difficulty, i.e. market timing
P – Portfolio size impact (market disruption from large switches)
T – Tax liability (capital gains crystallised)
Reasons to review investment strategy
· Liability structure may have changed significantly
· Funding or free asset position may change significantly
· Manager’s performance may be significantly out of line with another fund
- following writing new class of business
- takeover
- benefit improvements
- legislation
Funding =benefit schemes
Free assets= insurance
How to analyse the investment performance of a fund vs benchmark? Limitations?
Record all the cashflows into and out of the fund (e.g., deposits, withdrawals) – including dates.
Also record daily values of the benchmark over the same time.
Using a spreadsheet, you can simulate what would have happened if you invested the fund’s cashflows into the benchmark instead of whatever the fund manager actually chose.
You compare:
The actual fund value (based on the fund manager’s decisions)
With the simulated benchmark-based value (if the fund just tracked the index)
If index includes income reinvested, then divs and interest on actual pf aren’t incl. as cfs but incl. in valuing end period value of assets
If benchmark is capital only then they are included
Define active risk
Risk taken when investment manager has freedom over stock selection, and use their skills and research to maximise the return within the given guidelines. This typically relates to any deviation from the benchmark that was given to the manager
Define strategic risk
Risk of poor performance of strategic benchmark relative to value of liabilities
Define structural risk
A fund may have total benchmark expressed i.t.o an index or its peers’ investments. But the investments in the index or peers may change and there may have some delay in understand the new constituents
