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CFA L3 Matheus > Section 5 - R27 - Investment Manager Selection > Flashcards

Section 5 - R27 - Investment Manager Selection Flashcards

1
Q

Key Asspects in Manager Selection (List)

A
  1. Define the universe (suitability, style, active or passive)
  2. Quant Analysis (track record, capture ratios, attribution and appraisal, drawdown)
  3. Qualitative Analysis:
    - Investment Due Diligence (philosophy, process, people)
    - Operational Due Diligence (philosophy, investment vehicle, terms, monitoring)
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2
Q

Types of Errors in Investment Manager (List and Explain)

A

H0: Investment Skill = 0

Error Type 1: H0 is true. Error is to reject and CHOOSE manager.
- Should have rejected manager

Error Type 2: H0 is false. Error is to NOT reject and AVOID manager.
- Should have accepted manager

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3
Q

Errors Type 1 and Type 2 implications (Describe)

A

Type 1: Errors of Comission.
- Should have rejected manager.
- Hired underperforming manager.
- Psychologically more painful.
- Cost: Explicit. More transparent.

Type 2: Error of Omission.
- Cost: Opportunity (Comission)
- If consistent error, shows weakness of the investment manager selection process

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4
Q

Difference in expected cost between Type I and Type II (Describe)

A

Higher the smaller the perceived difference between the distribution of skilled and unskilled managers.

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5
Q

Quantitative Elements of Selection (List and Describe)

A
  1. Style Analysis
  2. Returns Based Analysis
  3. Holdings Based Analysis
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6
Q
  1. Style Analysis
A
  1. Style Analysis: Understanding
    the manager’s risk exposures relative to the bench + how they evolve over time.

Must be:
- Meaningful (reported risks must represent important sources of risk exposures)

  • Accurate (must reflect actual risk exposures)
  • Consistent (methodology must allow for comparison over time)
  • Timely (information should be timely)
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7
Q
  1. Returns Based Analysis
A
  • Top down approach
  • Estimate portfolio’s sensitivities to security market indexes representing risk factors

Pros: easy to manipulate, not too much data to compile
Cons: imprecise, not accurate, may not reflect future holdings, illiquid holdings may have stale prices

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8
Q
  1. Holdings Based Approach
A
  • Bottom up approach
  • Point in time analysis

Pros: Comparable across managers and through time

Cons:
- Complex
- Subject to window dressing
- Requires Transparency
- May not reflect portfolio going fwd

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9
Q

Qualitative Elements of Selection (List and Describe)

A
  1. Investment Philosophy: Manager’s underlying assumptions that drive the investment performance, including inefficiencies
  2. Investment Personnel: Is there sufficient personnel with the adequate experience and expertise?
  3. Investment Decision Making Process: Signal creation, signal capture, portfolio construction, monitoring.
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10
Q
  1. Quali: Investment Philosophy (Describe)
A

Manager’s underlying assumptions that drive the investment performance

  • Strategy:
  • Passive (Premium = f factors)
  • Active (Premium = f mispricing)
  • Inefficiencies:
  • Behavioral (temporary)
  • Structural (Permanent)
  • Other Assumptions:
  • Market Convergence
  • Correlations
  • Macro Influence
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11
Q
  1. Investment Personnel
A
  • Sufficient experience, expertise and depth?
  • Is there key person risk?
  • Turnover
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12
Q
  1. Investment Decision Making Process
A

a. Signal Creation: Generate idea
b. Signal Capture: Translate in an investment idea. Repeatable?
c. Portfolio Construction: Implement Position
d. Monitoring.

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13
Q

Investment Vehicles (List)

A
  1. Individual Separately Mgd Account
  2. Pooled / Comingled Vehicle
    9.
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14
Q
  1. Individual Separately Mgd Account (Describe)
A
  1. Individual Separately Mgd Account
  • Ownership: Não afeta outros investidores. Clear legal ownership.
  • Customization: Accomodate constraints / preferences
  • Tax Efficiency: No other withdrawals
  • Transparency: Real Time Information

Cons:
- Escalation issues
- High costs
- Tracking Risk (Customization)
- Attribution messy due to constraints

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15
Q
  1. Pooled / Comingled Vehicle (Describe)
A
  • Money from multiple investors held as a single portfolio
  • No customization
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16
Q

Vehicles Liquidity (List)

A
  • Most Liquid: ETF
  • Open-ended funds
  • Limited Partnerships (HFs)
  • Private Equity & Venture Capital
17
Q

Hedge Funds Liquidity Characteristics (List)

A
  • Redemption Frequency
  • Notification Period
  • Lockup (hard or soft, w/ penalties)
  • Gates (limit amounts withdrawn at redemption date)
18
Q

Limited Partnership (Pros and Cons)

A

Pros:
- May hold illiquid assets
- Reduced risk of having to sell at bad times
- Removes potential for overreaction

Cons:
- Less flexible
- Less liquid

19
Q

Terms of Investment (List of Items)

A

a. Liquidity
b. Management Fees (for operating and fixed costs)
c. AuM Fee (to retain capital and increase asset value)
d. Performance Based Fees

20
Q

Performance Based Fees (List and Explain)

A

1) Fully exposed to upside and downside (Ex: Mínimo +- 25bps)

2) Bonus structure with limited downside. Mínimo + Upside ilimitado (Ex: Mínimo + 20% do upside). Nunca menor que o mínimo.

3) Bonus with limited upside and downside. Not necessarily simmetrical.
Ex: Curva S do Itaú BBA

21
Q

Performance Fees Characteristics (List)

A
  • Paid annually
  • High watermarks
  • PE, HF and Real Estate funds unlimited
  • If managers control profit realization, they may have an incentive to hold on to assets until profit is realized
  • HF managers may want to sell funds if they are already below water mark (mv portfolio < high water mark)
22
Q

Quantitative Analysis in Selecting Manager (List)

A
  • Track Record
  • Capture Ratios
  • Attribution and Appraisal
  • Drawdown
23
Q

Qualitative Analysis in Selecting Manager (List)

A
  • Investment Due Diligence (Philosophy, Process, People)
  • Operational Due Diligence (Philosophy, Investment Vehicle, Investment Terms, Monitoring)
24
Q

How Performance Based Fees Impact Volatility?

A

Performance-based fee structures convert symmetrical gross active return distributions into assymetrical net active return distributions, reducing variability on the upside but not the downside, providing miscalculation in risks

25
Q

Standard Fee (Concept)

A

If you achieve (a) breakeven active return, you will pay (b) standard fee.

26
Q

Net Active Return (Formula)

A

(a) Net Active Return = Active Return - Billed Fee

(b) Billed Fee = Base Fee + Additional Participation Fee * (Active Return- Base Fee)

27
Q

Which Manager’s Fee Structure is Similar to a Call?

A

Bonus-style fee with a maximum fee feature. It is the most similar / equivalent to a call option on a share of active return for which the base fee is the strike price minus another less valuable call option with a strike equal to maximum fee.

CFA L3 Matheus (18 decks)

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