Chapter 21: Portfolio management (1) Flashcards
List nine investment management styles
- Active
- Passive
- value
- growth
- momentum
- contrarian
- rotational
- top-down
- bottom up
Desribe the general characteristics of growth stocks, and list 5 factors that you might use to identify them
Growth stocks that are expected to experience rapid growth of earnings, dividend and hence price
Five factors use to identify growth stocks
- Return on equity
- earnings growth
- earnings revisions
- forecast earning growth
- sales growth
Describe the general characterisitcs of value of stocks, and list five factors that you might use to identify them
Value stocks are stocks that seems to repersent good value in terms of ertain key accounting ratios
Five factors use to identify value stocks
- Cashflow yield
- Book to yield
- earnings yield
- dividend yield
- sales to price
Distinguish between active and passive investment management
Active investment management
- Seeks to actively identify mispriced securities, which can then be traded to generate large returns
- stock selection, sector selection, switching, market timing
- Requires inefficient market
Passive investment management
- Involves selecting securities that beset meet investor’s objectivesand/or make up investor’s benchmark portfolio
- securities then held passively and changed only in reaction to change iin objecti8ves and/or benchmark portfolio
- eg index tracking, liability matching/hedging
- Appropriate if market efficient
Explain briefly what is meant by each of the follwing investment management styles
- mOMENTUM
- CONTRARIAN
- ROTAITONAL
Momentum
Momentum investors purchases(sell) stocks that have recently risk (fallen) significantly in price on belieft that they will continue to rise (fall) owing to an upward (downward) shift in their demand curves, thereby taking advantage of momentum effects
Contrarian
Investors do opposite to most other investors in belief that investors, and hence share prices, tend to overreact to news
Rotational
Rotational investors move between countries, sectors, industries or value and growth stocks depending on which style is blieved to be attractive at any particular point in time, ie growth when market rising, value when market falling
Outline the top - down and bottom up approaches to portfolio construction and state their relative merits
Top down approach
- First consider asset allocation between different asset classes
- next considers, how to distribute available fund between different sectors (eg different industries for equities) within each asset class
- Finally selects individual assets within each sector
- better control of risk of portfolio, as it ensures diversified portfolio and matching of liabilities focuses more on asset class choice, which has greatest overall effect on investment performance
Bottom up approach
- Selects best value individual securities, irrespective of geographical or setoral spread
- Focuses on choice of individual securities, whose performance actually ditates that of portfolio as whole
Define the following types of analysis
- Fundamental anlaysis
- quantitative analysis
- technical analysis
Fundamental analysis
Analysis of company’s share value adn potential for future profits and dividends based accounting and economic information
Quantitative analysis
Modern mathematical techniqies used to aid stocka and sector selection, ie asset pricing models in Chapter 18
Technical analysis
Analysis of historical market date on prices, yields and/or trading volumes to predict future market movements
List the three ways of traching an index
- Full replication - holding all securities in index in proportion to index weighting
- Sampling or partial repication - holding representative sameple of securities in index, which behaves in same way as index
- Synthetically replicating index using derivatives and cash
Outline four potential advantages and five potential disadvantages of index tracking compared to active portfolio management
Four potential advantages of index tracking
- Risk of under performance index (and indirectly competitors) reduced
- lower dealing and research costs
- appropriate if market believed to be efficient
- tracking well diversified index ensure fund is well diversified, reducing specific risk and volatility of returns
Four potential disadvantages of index tracking
- Chance of over - performance index (and indirectly competitors) reduced
- Full replication involves forced buying/selling when index constituents changed and fragmented portfolio
- Resulting strategy may pay insufficient regard to investor’s objectives
- May prove difficult to find appropriate index to track
- May prove difficult to accurately track chosen index
State
- 2 conditions required in order for active investment management to be appropriate
- One potential advantage and two difficulties with active mangement
Appropriate if
- Market inefficient
- possible to identify skilled investment managers who can explit market inefficiencies
Advantage
- Offers possibility of higher returns
Difficulties
- Selecting out-performing investment managers
- timing changes to line up of active managers
Outline the two types of mandates under which active investment managers typically operate
- Multi - asset or balanced mandates - manage funds invested across a variety of different asset categories and will take decisions on:
- Weightings across asset categories
- And stocks within each asset category
- Specialist mandates - specialise in particular asset category and employed to manage unds invested in that asset category only
Describe the core satellite approach to portfolio management
- Majority of fund (‘core’ portfolio) managed on passive , low cost basis
- Specialist satellite, active managers employed to provide increased perfomance (in excess of fees paid) in respect of balance of fund
- Number of competing managers may be employed in respect of specialist asset classes
- Satellite managers may include hedge fund and private equity specialists
List circumstances in which an individual bond will outperform its peers and outline why the return on a bond will probnounced negative skew
A bond could outperform its peers
- If the issuer’s (relative) percieved creditworthiness improves
- If the issue’s term, liquidity or other trading aspects improve
- If there is a supply/demand imbalance
Bond returns have a negative skew because
- a bond’s outperformance is bound (by highest rating category, and realistic interest rate changes)
- A complete loss of value could occur
Describe
- Anomaly switching
- policy switching
Anomaly switching
- involves moving between stocks with similar volatilities
- take advantages of temporary anomalies in price
- relatively low risk strategy
- profits likely to be small
Policy switching
- Involves taking view on future changes in shape and/or level of yield curve and moving into bonds with different volatilities
- eg if yields expected to fall, switch into longer dated, more volatile stocks
- Potentially high risk, high return approach
- need to consider matching
Give 3 techniques for identifying anomaly switches
- Compared current yield idfference between two similar bonds to recent avaerage value to determine if one of bonds seems cheap or dear relative to other
- Compare price ratios in similar way to yield differences, allowing for any differences in coupon level
- Use price and yield models. If actual price of yield differs from model prediction, then may be mis-pricing
