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FINM3008 > Portfolio management process and agency problems (Week 1) > Flashcards

Portfolio management process and agency problems (Week 1) Flashcards

1
Q

What is portfolio management

A

managing investment funds towards client’s objectives:

return, risk, liquidity, steady income stream, dividend v capital gains, tax minimisation

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2
Q

what objectives may a retired couple have?

A

leave enough money for their living

set up family trust

leave money for grand children

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3
Q

Superannuation funds

Corporate super funds

A

Corporate super funds by corporations. They have own team to manage for their employees

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4
Q

agency problem between investment bank and investors example

A

investment bank hired as asset consultant by institutional investor

investment bank evaluating several infrastructure projects e.g. second sydney airport, almond farming. recommend 1 alternative asset to institutional investor. Project calls them because they are consultants/advisor for the project. Gets finance for the project. and asks them to do them a favour and recommend their product to institutional investors. In return, they will receive benefit.

asset consultant may not recommend product that will be best interest of their client.

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5
Q

agency problem between investors and aggregators

A

investors delegates some of management decisions to board members of UNIsuper. are they competent or like to look after investor’s interest

board meets few times a year. how can they monitor investment managers of unisuper?

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6
Q

agency problem between investors and aggregators

A

investors delegates some of management decisions to board members of UNIsuper. are they competent or like to look after investor’s interest

board meets few times a year monitoring?

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7
Q

agency problem between investors and financial planners

A

buy Australian equity fund from colonial first instead of other. push you to buy products that generate the highest commission

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8
Q

agency problem between investors and financial planners

A

buy Australian equity fund from colonial first instead of other. push you to buy products that generate the highest commission

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9
Q

what happens when you delegate asset allocation decision to someone else?

A

agency problem

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10
Q

financial planner

A

over 70% of changes recommended by financial planners are not necessary. just want to generate sales and revenue.

still a lot of work in financial planning industry.

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11
Q

investment manager

A

they have their own access to particular asset

aware of new investment opportunities

better access to assets

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12
Q

where does the actual asset allocation or portfolio management happen

A

investment manager

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13
Q

where does the actual asset allocation or portfolio management happen

A

investment manager

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14
Q

where does the actual asset allocation or portfolio management happen

A

investment manager

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15
Q

Superannuation funds

SMSF

A

Need 200k to establish

manage own superannuation in account

compliance and reporting regulations

2012 regulation changed so they can borrow funds to buy real estate

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16
Q

Superannuation funds

Public-Sector

A

Defined contributoin.We pay you super guarantee but not going to guarantee certain amount of benefit.

What you receive when you retire depends on amount invested in account

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17
Q

Superannuation funds

Public-Sector

A

Defined contributoin.We pay you super guarantee but not going to guarantee certain amount of benefit.

What you receive when you retire depends on amount invested in account

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18
Q

Superannuation funds

Industry super fund

A

Low fees.

not for profit

value for money fund management

This year, industry super fund has been scrutinised about effectiveness for helping members. No sufficient supervision or monitoring, lazy portfolio managers charging flat fee and not doing their job

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19
Q

Endowment and Foundations

Harvard endowment

A

during GFC, harvard endowment was hurt badly because of illiquidity of alternative assets and could not offload onto alternative assets

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20
Q

Insurance companies?

A

have reserves to pay compensation

collect insurance premium from insurance policy and make investment and keeps investment returns

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21
Q

Types of agency issues

•Tiered approach to portfolio construction

−Buckets at various tiers of the process

−Portfolio => asset classes => portfolio managers => assets

A

several portfolio managers for equity asset class.

Some will be specialised in australian, european etc

portfolio construcuted by various tiers

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22
Q

Types of agency issues

A
  • Delegated management => agency problems
  • What investors want versus what managers want
  • Tiered approach to portfolio construction

−Buckets at various tiers of the process

−Portfolio => asset classes => portfolio managers => assets

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23
Q

An asset management decision process

•review

A

–Performance measurement & evaluation

–Monitor & adjust

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24
Q

An asset management decision process

•implement

A

how am i going to invest 60% of funds into high growth? australian equity? emerging equity?

–Asset class strategy & portfolio structure

–Manager or asset selection

–Execution

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25
Q

An asset management decision process

•Plan

A
  • governance
  • objectives and constraints
  • asset allocation
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26
Q

An asset management decision process

•Plan

–objectives and constraints

A

decide objectives and constraints

set up separate account to manage 5m for retired couple. are they trying to generate income for retirement living?

Given objectives and constraints, 60% in high growth assets and 40% in fixed income

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27
Q

An asset management decision process

•Plan

–Governance

A

set up a new fund, need to establish governance system to decide who is responsible for what. how performance is evaluated and their specific responsibilities

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28
Q

An asset management decision process

•Plan

A

–Governance

–Objectives & constraints

–Asset allocation

29
Q

Describe growth in alternative assets

A

alternative assets such as private equity, hedge funds, properties and infrastructures etc.

30 years ago 1% of average portfolio

Now 20% of average portfolio

30
Q

Funds management industry in relation to GDP

A

Funds management industry in relation is growing faster than GDP.

Growth market of funds management industry si 5-6% in most of developed market

31
Q

Trend in pension funds?

A

Australia pension funds have highest percentage of defined contribution funds. Members have full responsibility of funding their own retirement instead of receiving a certain amount of retirement benefit or pension

Japan, members are entited to certain amount. risky promise made by gov or corporation

32
Q

is there a shift from passive management strategies to active?

A

No, shift from active management strategies to passive partially because of high fees

e.g. Vanguard, ETF (active management strategies).

33
Q

Asset Allocation Process

A
  1. Understand Investor’s objectives and circumtances
  2. Transform investor’s objectives into quantifiable and unquantifiable measures
  3. collect financial and economic forecast data and conduct qualitative and quantitative analysis e.g. portfolio simulations
  4. Assign asset weights so that investor’s objectives can be achieved
  5. Decide how portfolio manager’s performance can be evaluated
34
Q

Feature of SMSF funds

A

Last 10-20 years, they have been growing faster than corporate and retail funds in australia

35
Q

identify 3 major trends observed over the last 5-10 years

Asset class trends

A

Reduction in equities – main counterpart to increase in alternative mentioned above.

– ‘De-risking’ by some investors, through increasing fixed income. Particularly notable for DB funds, who are responding to increasing deficits by aiming to hedge liabilities.

– Reduced home bias in equities, i.e. global diversification

– Reduced home bias in Australian bonds, mainly due to the fact that Australian bond market is very small relative to the world market

36
Q

identify 3 major trends observed over the last 5-10 years

Growth segments

A

Other ‘alternative’ assets: private equity and hedge funds (until 2007, then drift);

commodities in more recent years; infrastructure currently growing in popularity

– ETFs (exchange-traded funds)

– SWFs (sovereign wealth funds)

– Private wealth management

37
Q

identify 3 major trends observed over the last 5-10 years

GDP

A

High growth rates (faster than GDP) - although some stalling post-2007 / GFC

38
Q

Major Trend

Concentration

A

concentration of fund managers at top (Blackrock, Vanguard, State Street); but growth of boutique managers is also occurring

39
Q

Major Trend

increase in

A

Increase in passive investing, at expense of active funds

• Increased regulation

40
Q

Major Trend

increase in

A

Increase in passive investing, at expense of active funds

• Increased regulation

41
Q

Major Trend

DB and DC Funds

A

Movement towards DC pension funds, away from DB funds. Australian pension is dominated by DC, highest in the developed countries

Increases in DB fund deficits (GFC, lower interest rates, aging populations)

42
Q

Trend in Super

A

In Australian superannuation, ‘industry funds’ and self-managed super funds (SMSFs) winning share; while ‘retail funds’ (and corporate) struggling

43
Q

Two major drivers of volume and composition of funds under management (FUM)

Other influences of note:

A

– asset demand can be driven by: investor preferences; economic development; demographics, e.g. saving for retirement

– asset supply / availability – disintermediation – rebalancing of portfolios, i.e. shifting, or restoring, asset weightings

– regulation (e.g. restrictions on leverage; what assets SMSFs can include in the fund)

44
Q

Two major drivers of volume and composition of funds under management (FUM)

A

Asset returns, revaluation of assets within existing portfolios

Cash flows, i.e. investors making new investments, or redeeming

45
Q

Composition of FUM and finance theory (i.e. modern portfolio theory, CAPM)

A

Investor portfolios unlike the CAPM market portfolio (does not span all assets; home bias)

  • Markets are segregated with many frictions. More like “buckets” than integrated pool.
  • Multiple investors, structures and objectives. ‘Separation’ of MPT does not seem to hold.
  • ‘Delegated management’ to managers, with weak links to utility of consumption or wealth
46
Q

A number of agency problems arise from the delegation of the investment process to professional managers. Identify three such problems, and be able to discuss their nature and implications for investors.

  1. Commissions on product sales

Impliction

A

Investor directed towards managers paying highest front-end loads and trailers, not necessarily best managers for investor. (Note: Commissions being purged in Australia.)

47
Q

A number of agency problems arise from the delegation of the investment process to professional managers. Identify three such problems, and be able to discuss their nature and implications for investors.

7.

A

Commissions on product sales

48
Q

A number of agency problems arise from the delegation of the investment process to professional managers. Identify three such problems, and be able to discuss their nature and implications for investors.

  1. Brokerage and other costs paid by investor, but controlled by the manager

implication

A

Open for abuse by manager – brokers can offer benefits to manager (e.g. entertainment) to get them to trade

• Example: ‘soft dollar’ transactions (these involve brokers paying for certain services in return for a promise to pay brokerage - mostly frowned upon)

49
Q

A number of agency problems arise from the delegation of the investment process to professional managers. Identify three such problems, and be able to discuss their nature and implications for investors.

6.

A

Brokerage and other costs paid by investor, but controlled by the manager

50
Q

A number of agency problems arise from the delegation of the investment process to professional managers. Identify three such problems, and be able to discuss their nature and implications for investors.

  1. Incentives to increase risk when ‘optionality’ exists for manager (e.g. bonus paid on yearly returns; performance fees; high leverage)

implication

A
  • Options are more valuable under high volatility => incentive to take risk (‘heads I win, tails you lose’)
  • Investor subjected to more risk than appreciated
  • More of an issue in hedge funds, private equity, etc
51
Q

A number of agency problems arise from the delegation of the investment process to professional managers. Identify three such problems, and be able to discuss their nature and implications for investors.

5.

A

Incentives to increase risk when ‘optionality’ exists for manager (e.g. bonus paid on yearly returns; performance fees; high leverage)

52
Q

A number of agency problems arise from the delegation of the investment process to professional managers. Identify three such problems, and be able to discuss their nature and implications for investors.

  1. Ongoing evaluation of manager performance

implication

A

This can lead to ‘short-termism’, i.e. managers trying to maximize short-term returns, rather than longer-term performance

53
Q

A number of agency problems arise from the delegation of the investment process to professional managers. Identify three such problems, and be able to discuss their nature and implications for investors.

4.

A

Ongoing evaluation of manager performance

54
Q

A number of agency problems arise from the delegation of the investment process to professional managers. Identify three such problems, and be able to discuss their nature and implications for investors.

  1. Peer ranking considerations
A
  • Reluctance to try something new, even if in investor’s best interest, as raises risk of underperforming peers.
  • Manager “career risk” (i.e. risk of losing one’s job due if one of the worst performers) leads to benchmark hugging and other forms of herding
55
Q

A number of agency problems arise from the delegation of the investment process to professional managers. Identify three such problems, and be able to discuss their nature and implications for investors.

3.

A

Peer ranking considerations

56
Q

A number of agency problems arise from the delegation of the investment process to professional managers. Identify three such problems, and be able to discuss their nature and implications for investors.

  1. Benchmark
A

Benchmark need not align with investor objectives

Managers may game benchmark by either seeking risk premiums or off-benchmark exposures

Varying risk to manage relative performance (i.e. hug benchmark if ahead, go for broke if behind). Investor gets not enough risk, or too much.

57
Q

A number of agency problems arise from the delegation of the investment process to professional managers. Identify three such problems, and be able to discuss their nature and implications for investors.

2.

A

Managing to benchmarks

58
Q

A number of agency problems arise from the delegation of the investment process to professional managers. Identify three such problems, and be able to discuss their nature and implications for investors.

fund management companies and fund managers have incentive to increase fees and FUM (profits and bonus motives) while investors

implication

A
  • Managers want to keep fees as high as possible, but this directly reduces investor returns. (Good managers will sometimes be able to charge a higher fee.)
  • If FUM increase beyond reasonable capacity for strategy, returns are eroded.
  • Result is that much of the value-add from investment skill may be secured by manager themselves, rather than accruing to investors.
59
Q

A number of agency problems arise from the delegation of the investment process to professional managers. Identify three such problems, and be able to discuss their nature and implications for investors.

fund management companies and fund managers have incentive to increase fees and FUM (profits and bonus motives) while investors

implication

A

fund management companies and fund managers have incentive to increase fees and FUM (profits and bonus motives)

while investors want to maximize portfolio return

60
Q

The main agency problems in fund management do not relate to information asymmetry, but rather relate to

A

lack of alignment (incentives, objectives).

61
Q

Performance Evaluation.

Performance evaluation provides a

A

regular assessment of the fund’s performance relative to your investment objectives. Properly conducted, performance evaluation reinforces the hierarchy of accountability, responsibility, and authority defined in the fund’s governance structure. Performance evaluation serves as a feedback-and-control mechanism by identifying the investment program’s strengths and weaknesses

62
Q

Goal of Asset allocation

A

to manage variability, provide for cash flow needs and generate asset growth

i.e. risk and return, either absolute or relative to a target or benchmark

63
Q

How is the client diversified

A

By holding investments in reasonably uncorrelated assets

64
Q

many portfolio managers do not make asset allocation decisions. Instead,

A

they are hired to run a pool of money in a single asset class, or style within an asset class.

65
Q

Payment by DB Funds is determined by

A

a pre-specified wage-based formula

66
Q

Portfolio manager’s goal in DB Funds

A

to set both asset allocation and funding policities to meet its schedule of forecast future cash flows at the lowest possible cost and lowest risk of falling short of the required outflows

67
Q

DC Plan is a hybrid program

Role of Portfolio manager

A

portfolio managers are hired by the company to provide diversified multi-asset options, individual asset class management and customised asset allocation advice

68
Q

DC Plan is a hybrid program

A

employee determines how to save and how to invest

company supports this effort with contribution matching and advisory support services

FINM3008 (15 decks)

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