CIPM Level 1 Flashcards
1
Q
Members must
A
- act with integrity, competence, and diligence
- put profession and clients above self
- care and independence in analysis
- encourage others to be ethical
- promote health of market and society
- maintain/ improve professional competence
2
Q
Professionalism
A
- knowledge of the law
- independence and objectivity
- misrepresentation
- misconduct
3
Q
Integrity of capital markets
A
- material nonpublic information
- market manipulation
4
Q
duties to client
A
- Fair Dealing
- Loyalty, prudence, and care
- suitability
- ask about experience, risk, goals, constraints, etc
- check decisions against answers to these questions
- Evaluate investments based upon this context
- Performance Presentation
- Preservation of confidentiality unless:
- illegal activities
- client permission
- Required by law
5
Q
Duties to Employer
A
- Loyalty
- Additional Compensation
- Responsibilities of Supervisors
6
Q
Analysis, Recommendations, Actions
A
- Diligence
- Be diligent in analysis
- Have reasonable support for actions
- Communication with Clients and prospective clients
- Disclose general investment process
- Disclose limitations/risks
- Use reasonable judgment
- disclose what is fact and opinion
- Record retention
7
Q
Conflicts of interest
A
- Disclose conflicts of interest
- Priority of transactions\
- Referral Fees
8
Q
Responsibility as CIPM Members
A
- Conduct as members
- reference to CIPM
9
Q
4 questions of performance measurement
A
- How did portfolio achieve outcome and what are expected sources of future returns?
- Was observed performance luck or skill?
- Which managers should be hired/fired/kept?
- What info should be reported and how?
10
Q
Book Value
A
Price at time of trade
11
Q
Fair Value Price
A
The price it could be sold for
12
Q
Unrealized gain/loss
A
Change in market value
13
Q
Realized Gain/Loss
A
That value once it is redeemed(the asset is sold)
14
Q
Issues with external cash flows
A
- Cash flows might not be manager decision so input of cash flows might not be fair
- Returns cannot be calculated based solely on beginning and ending value
- Exact dates and values of necessary events and flows may be expensive so can be approximated
15
Q
When is time-weighted appropriate?
A
- When there is a need to neutralize impact of flows
- When comparing portfolios
- When measuring manager not fund
16
Q
When is money-weighted appropriate?
A
- When accurate values are not available
- When manager is responsible for flows
- When time value of money matters
17
Q
Ways to calculate composite returns
A
- Calculate returns using BMV weights
- Use weights from denominator of modified Dietz
- Calculate as a single portfolio
18
Q
Attribution vs Contribution
A
Contribution doesn’t use a Benchmark
19
Q
Returns based attribution
A
Looks at TF returns over time to look at factors (easiest and least accurate
20
Q
Holdings based attribution
A
–misses transactions between measurement times so will not reconcile
21
Q
Transactions based attribution
A
-uses both holdings and transactions and is the most accurate
22
Q
Multi level attribution
A
Macro-Level: sponsor level
Micro- Level: manager level
23
Q
Advantages of Factor Model
A
- Flexible
- Can use different models to capture different effects
- Can be made very sophisticated
24
Q
Disadvantages of Factor Model
A
- Usually applied to single asset class
- Limited by factor used
- Can be significant computational costs
- Less consistency
- Can be less intuitive
25
Fixed Income return attribution
Duration: % change in bond price based on unanticipated change in interest rates
Convexity: nonlinearity in relationship between price and yield change
Credit Spread: Premium paid for riskier bond
26
Problems in return attribution
-Data input
- Residuals
* could be missing data
* missing categories
* missing instruments (i.e., currency effects)
* inconsistent return methodologies
*incomplete model
(arithmetic returns will not add up over time)
27
Off benchmark decisions
- You can handle it normally but give benchmark 0 weight
- Give allocation effect a zero for the sector
- Give the sector only an allocation effect
28
Benchmark Uses
- reference point
- instruction communication to manager
- instruction communication to consultant
- identification of risk
- interpretation of past performance
- manager selection/appraisal
- demonstrating compliance
29
Types of benchmarks
- absolute return
- manager universe
- broad market index
- factor-model based
- style index
- returns based
- custom security based
- peer group
30
properties of a valid benchmark
- unambiguous
- investable
- measurable
- appropriate
- reflective of current investment opinions
- specified in advance
- accountable
31
Evaluating benchmark quality
- Correlation between active return and style is statistically indistinguishable from zero
- Correlation between E (difference between portfolio and market) and style is greater than zero
- Standard deviation of A is less thanks standard deviation of E
- Betas should be stable over time
- Fore equities, benchmark should have low turnover (<15-20%)
- Should be investable without incurring high trading costs
- Low proportion of zero weight securities
- Should have high Coverage
32
Examples of inclusion criteria
- minimum trading price
- minimum available shares
- minimum liquidity
- company structure
- share types
- country assignment
33
Types of Benchmark weighting
- capitalization weighted
- value weighted
- price weighted
- equal weighted
- fundamental weighted
- optimization weighted
34
Free float inclusion criteria excludes:
- Cross ownership
- Large corporate/private holdings
- Employee owned shares
- IPO lockups
- government holdings
** Free float adjustment is particularly important in less developed countries
35
Index Rules
- reconstruction/rebalancing intervals
- corporate action handling
- dividend inclusion
36
Index tradeoffs
- Completeness vs investability
- Reconstitution and rebalancing frequency vs turnover
- Objective and transparent rules vs. judgment
37
Pros of weighting schemes
Market Cap- unambiguous, macro consistency, reflects CAPM, requires less rebalancing
Price- simple, long track record
Equal- Less influenced by large issuers
Fundamental- less subject to bubbles and market inefficiencies
Optimization based- plots on the efficient frontier of risk and reward
38
Cons of weighting schemes
Market cap-influenced by large issuers
Price- influenced by overpriced securities, stock splits reduce influence of successful companies, assumes investors hold one unit of every asset
Equal- small issuer bias, frequent rebalancing, small issuers might be too illiquid to be investable
Fundamental- often less diversified, might not be investable, often not fully known, tilted toward small cap, tend to outperform market cap bm's although this isn't really the goal of a benchmark
Optimization- can be over-concentrated in low risk securities, uses historical data that may not be good indicator of future
39
Problems with assigning a manager a style
- Often oversimplified and do not reflect n entire approach
- process is subjective and difference process gets different results
- fund may change over time
- designation often leads to peer group comparison which has its own problems
40
Bond index characteristics
- Issuer: Corporate, government, municipal, asset backed security, mortgage backed security
- Credit risk: investment grade, high yield
- Finer
- Corporate: industrial, utilities, financial
- Investment grade: AAA,AA,AA,BBB
41
Fixed Income Inclusion Criteria
country, credit risk, liquidity, maturity, sector
Typical list:
- publicly issued
- Nonconvertible
- Dollar denominated
- fixed coupon or one that changes regularly
- Maturity>1year
- meet minimum issue size
- fulfill necessary credit rating
42
Problems with bond indexes
- Bonds don't trade as easily as socks so prices are often stale
- bond indexes are often based on appraised prices not traded prices
- using appraised value can bias standard deviation downward
- many bond indexes struggle with illiquidity (some will offer a more liquid subset to fix this)
- because bonds are so heterogeneous, seemingly similar indices can have very different returns
- Usually a lot of turnover due to updates for maturity, new issues, etc.
- Bums problem: more weight is given to big borrowers who are more likely to be down-graded
- Bonds that try to fix bum problem end up being even less liquid
43
Steps to create custom benchmark
- identify features of the manager's process
- select securities appropriate for that process
- develop security weighting scheme and be sure to include cash
- review and make adjustments
- rebalance periodically
- document all changes
44
Hedge Fund Benchmark difficulties
- Hedge funds don't have specific asset class
- They reflect manager attempts to exploit inefficiencies
- so...
- they can have unlimited universe
- they can vary a lot from one to another
- they can change over time
- they can be highly leveraged
- they often lack transparency
- traditional weights don't apply
45
Hedge fund benchmark solutions
- Absolute returns X: Hedge funds change too much
- risk free benchmark X: HF's are not risk free and risk changes when arbitrage comes into the picture
- broad market index X: Often weakly correlated
- manager universeX: survivorship bias,selection bias, and prices are reported infrequently and unverified
- Create custom benchmarks for long and short positions using returns-based or holdings based analysis
46
Components of Liability Portfolio
- Economy
- Past earnings
- Future Earnings
Liability relative benchmark is constructed to meet future obligations
47
Types of Risk
Financial
- Credit: Debtor doesn't pay
- Market: assets are hard t trade or can't be traded
- Liquidity: Broad category including changes in currency, interest, commodities, etc.
Non-Financial
- Operational risk- systems fail within company
- Model risk- model fails or is misspecified
- Settlement risk- the buyer fulfills his role but the counterparts fails to settle
- Regulatory Risk
- Legal/Contract risk
- Tax Risk
- Sovereign/Political Risk- government action
- Accounting risk-uncertainty how to record a transaction
48
Risk measurement and attribution can be helpful for...
- investment policy definition
- portfolio construction
- portfolio analysis
- Enterprise Risk
49
Risk classification
- Ex ante
- Ex Post
- Stand alone
- idiosyncratic
- systematic
- Portfolio
- Absolute
- Relative
- Difference between risk of asset and liabilities is relative and is called surplus risk
- Difference between risk of investor trying to outperform bm and bm is relative and is called active risk
- Symmetric
- Asymmetric
50
Risk distribution
If mean>median, positive skewness
| If mean
51
Total risk
Probability of extreme loss
52
Downside risk
Potential for loss
53
Problems with measures of downside risk
- symmetric risk values are more familiar and usable
- use only half available information so lack statistical power
- If returns are symmetric around mean, the downside risk adds no new info and if they are not, downside risk is less stable over time
- There are no ways to aggregate downside risk of multiple assets
- Target semi variance requires specification so adds subjectivity
54
Drawdown pros and cons
Pros
- often used for hedge funds and commodity funds because other metrics are less valid with returns that diverge from a normal distribution
- and because they often coincide well with the compensation plans of these vehicles
Cons
- Does not tell us much unless coupled with other information
- represents time series data into a single number so you get bad comparisons if you use different time-periods because ceteris paribus, longer periods can have larger drawdowns
55
Value at Risk Methods
- Analytical
- just requires average return and standard deviation
- assumes normality
- Historical
- assumes that past performance predicts future performance so new issunigs complicate calculation
- simply derives a P value using ranked returns (there is a 10% chance you will get the 10th highest return in a list of 10 returns)
- Monte Carlo
- can be very complicated but are great for portfolios like hedge funds where other assumptions are not appropriate
56
Investment Characteristics
- Valuation measures
- Interest rate sensitivity
- Sector Industry Classification
- Geographic Exposure
- Type of Issuer
- Investment Structure
- Credit Quality
- Liquidity
- Leverage
57
Types of Risk Appraisal
- Bottom up (security managed contribution to risk)
- Top Down
- Factor Exposure
58
Investment Appraisal Questions
- Do returns sufficiently compensate investor for risk
- How does portfolio compare to peers?
- Is performance from luck or skill?
59
Qualitative Considerations in Manager Selection
- Suitability
- Complementarity
- Firm
- People
- Investment Process
- Operational process
- Transparency
- Costs
60
Approaches to benchmarking managers
- Third party categorization
- Returns based style analysis
- Holdings based style analysis
- Manager Experience
61
Type 1 error
hire bad manager
62
Type 2 error
fire/don't hire good manager
63
Manager evaluation parameters
- relative performance to peers and benchmark
- style drift
- operational issues
64
Manager Evaluation Questions
- Is there a difference between hired and not hired managers
- Are these differences consistent with investment philosophy?
- Are there identifiable factors driving the hire/fire decision?
- Are these factors consistent with investment philosophy?
- What is the added value of the hire/fire decision?
65
Implications of the hire/fire decisions
- performance implications
- transaction costs
- redemption fees
- hold backs
- tax liabilities
- portfolio implications
66
4 Attributions of effective risk reporting
- meaningful
- accurate
- consistent
- Timely
67
Active vsPassive Strategies
Passive- seek to capitalize on risk premiums
| Active- Behavioral vs Structural inefficiencies
68
Pros and cons of SMAs
Pros
- ownership
- customization
- tax-efficiency
- transparency
Cons
- cost
- tracking risk
- investment behavior
69
Operational Red Flags
- Change in auditor
- Affiliated broker/dealer
- Inconsistent transparency
- Unconfirmed work history
- Legal issues
