Chapter 17 - Investment Management Flashcards
What is active investment management?
Investment manager has few restrictions on the choice of investments and actively seeks to capitalise on under- and over-priced assets to enhance investment returns..
What are some theoretical advantages and disadvantages of active investment management?
Advantages:
Achieve higher returns by identifying and trading stocks in mispriced sectors in a market (sector selection profits)
Achieve higher returns by identifying and trading mispriced individual stocks (stock selection profits)
Disadvantages:
Extra costs are involved in performing regular transactions.
Manager’s judgement could be wrong and so returns may be lower than expected.
What is an efficient market?
Asset prices accurately reflect all available and relevant information at all times.
What is passive investment management?
Holding assets which closely reflect those underlying a certain index or specific benchmark. There is little freedom of choice for the investment manager.
What is index tracking?
Investor selects investments to replicate the movements of a chosen index. Changes in the portfolio only take place when the mix of the constituents of the index change significantly enough.
What are theoretical advantages and disadvantages of passive investment management?
Advantages:
Less expensive than active (less dealing and research costs`)
Disadvantages:
Index may perform badly
May be tracking errors
What is tactical asset allocation?
Short-term switching between investments in pursuit of higher returns.
What is strategic asset allocation?
Setting the relatively long-term structure of a portfolio.
What are the considerations which need to be made before making a tactical asset switch (6)?
Expected extra returns to be made relative to the additional risk (Risk adjusted returns)
Constraints on changes which can be made to the portfolio
Expenses involved
Practical problems involved with switching a large portfolio of assets
Tax liability if a capital gain is crystallised
The timing of the switch relative to other liabilities and operations.
What is 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 expected return.
What are the two parts of risk budgeting process when budgeting for investment risk?
Deciding how to allocate the maximum permitted overall risk between strategic risk and total fund active risk - ie how much total risk managers can take to outperform their benchmark while not departing too far from the theoretically matched position.
Allocating the total fund active risk budget across the component portfolios.
he key focus when setting the strategic asset allocation is the risk tolerance of the stakeholders in the fund.
This is the systematic risk they are prepared to take on in the attempt to enhance long-term returns.
The key question on active risk is whether it is believed that active management generates positive excess returns.
Risk budgeting is, therefore, an investment style where asset allocations are based on an asset’s risk contribution to the portfolio as well as on the asset’s expected return.
Describe the two-stage process for managing an investment fund.
The strategic benchmark must be set by establishing an appropriate asset mix for the fund. This will take into account the nature of the liabilities. The strategic risk will also need to be considered. This is the risk of poor performance of the strategic benchmark relative to the value of the liabilities.
The fund manager/s are selected and a decision on the appropriate level of risk these managers should take on relative to the strategic benchmark. The manager/s will have freedom over stock selection and use their skills and research to maximise returns on their allocated funds. The risk that these returns are less than expected is known as active/manager/implementation risk. Active risk could be measured as the standard deviation of the active return which the manager achieves.
What is the active return?
Return achieved by a fund manager relative to their given benchmark.
What is a zero-active risk approach?
This would be when a fund manager is simply instructed to track an index, such as to aim for an active return of 0%.
What does the overall risk of a portfolio consist of?
Strategic risk
Active risk
Structural risk (associated with any mismatch between the aggregate of the portfolio benchmarks and the fund benchmarks)
