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56 Cards in this Set
- Front
- Back
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Inflation is a concern when investing. How are bonds or equity as an inflation hedge?
What are some considerations with equity as an inflation hedge? What is ability of passing on inflation to consumers based upon? |
Bonds are a poor inflation hedge because all CF's are subjected to inflation.
Equity has been a good inflation hedge. 1) It is important to note that inflation still affects stock because corporate income and capital gains tax rate are not indexed to inflation. Hopefully this is priced into the stock price. 2) Ability to hedge inflation will depend on industry and competition. The more competition, the hard it is to pass on inflation to their consumers, and takes a hit to stock price. |
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Compare the differences between Passive, Active, and semi-active investment What is active return? |
Passive investment do not use forecasts and needs to rebalance according to the index it follows. Active - constitutes the vast majority of investments in the world. Semi-active - aims to earn a higher return than passive while minimizing risk from deviating from the benchmark. Active return is the excess return of a manager relative to the benchmark. |
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What is the Information Ratio and which active has the highest? |
It is Active Return/Active Risk. Historically has been the highest for semi active and lowest for passive. |
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If an investor's assets are taxable, what type of passive/active management will be favored?
If markets are efficient, which mgt is more favorable?
What is suitable for investing in large cap, small cap, and international stocks. |
A passive portfolio is more favored in taxable accounts because active management creates too much turnover and would realize taxes more frequently.
If a market is priced efficiently, then it is too difficult for active management to justify costs of research and trading.
Large cap- Indexing is more suitable because the stocks are priced efficiently. Small cap- High turnover = active management International - Management may not know the market so a passive might be better.
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What are the advantages and disadvantages of a price weighted index? |
A Price wgt index just adds all the prices of the stocks and divide by # of stocks.
It implicitly assumes there is one of each stock in the portfolio.
It automatically adjusts for stock splits and changes in composition of the market. Automatically meaning you need to change the divisor
Simple to calculate and has a long history of data. |
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What are the advantages of a market cap weighted index? Review other question earlier |
Calculated by summing the total market value of the index. Assumes an investor holds the # stock according to its market value in the index.
Better represents the changes in the aggregate investor.
Also automatically adjusts for the stock splits.
Free Float-adjusted market cap index: Market cap is adjusted for the amount of stock that is available to the public. |
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What is an equal weighted index? |
All stock returns are given the same amount of weight in the index. |
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What are the biases in the Price Weighted, Market Cap, and equal weight schemes? |
Price Weighted: 1) Higher priced stocks will have a greater impact 2) Price of a stock is somewhat arbitrary in reality. 3) Assumes the investor purchased only 1 share. Value Weighted: 1) Greater market cap stocks have greater impact. 2) Large firms bias, may affect diversification. Equal weighted index: 1) Biased towards small cap stocks 2) More rebalancing = higher transaction cots. 3) May not find any liquidity in the issues. |
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What are the two methods that an index uses to re-constitutionalize stocks?
What are the differences between the 2 rules? |
Index reconstitution is the process if adding and deleting stocks from an index.
By a committee: Lower turnover -> transaction costs -> taxes
By a mechanical rule: More turnover but less drifting.
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What are the differences between an Index Mutual Fund and an ETF? |
1) Index MF is less frequently traded 2) ETF's do not have to maintain shareholder records 3) Index MFs pay lower licensing fees. 4) ETF's are more tax efficient. Index MF sells could be a taxable event for the shareholder. 5) ETF brokerage may carry commissions, but the cost of holding a Index MF should be higher in the longer run. There is also a cost if there is a large liquidation. |
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In the CFA, how do they suggest SMA or Pooled accounts are used? |
SMA may offer index accounts for investors but min account size is very large. Pooled funds are basically a private mutual fund |
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Compare the disadvantages of using equity index futures as versus using ETF's. What is the uptick rule disadvantage? |
Futures have a finite life and must be periodically rolled over
Sales in a future must be at a price higher than the last transaction (uptick rule) |
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What are the 3 advantages in using equity return swaps? |
An investor can synthetically diversify a portfolio in one transaction.
Can be performed more cheaply than trading the underlying for TAA trades.
May be able to invest in foreign securities without triggering any WH taxes on them. |
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There are many ways of creating an index portfolio.
Describe the method of Full Replication and its nuances |
Full Rep is used when there are less than 1000 stocks in the index.
Very difficult and expensive to implement. Some securities are very illiquid. Low tracking risk and less rebalancing Cash drag because must set aside a small amount of cash for client redemptions.
Transaction costs in reinvesting dividends and changes in index. These costs are described in the text as low because they have self balancing properties. |
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There are many ways of creating an index portfolio.
Describe the method of Stratified Sampling and its nuances How do you decrease tracking risk with strat sampling? |
Separate the stock index into different dimensions
For each dimension or cell, use representative stocks.
Adv: Does not have to purchase all the stocks in the index
Tracking risk decreases if there are more cells in the structure |
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There are many ways of creating an index portfolio.
Describe the method of Optimization and its nuances |
A factor model used to match the exposures of the fund. Factor model accounts for the covariances between risk factors. This is only implicitly assumed in stratified sampling.
Possibly use objective function
Disadv Factor model is based upon historical data May create a misleading model if there is a skew in historical data. Optimization must be constantly updated to reflect changes in risk sensitivities.
Generally creates lower tracking risk. |
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Why is it important to define the investment style of a manager when considering performance? |
It is so that performance is conducted fairly in an apples to apples fashion. |
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Describe the value investing style. Why would this mispricing occur?
What are the 3 sub styles? |
Has a strong focus on P/E or P/B and desiring a stock that has a low ratio that has indication it will rise back in the future.
A firm may have depressed earnings now but it will revert back to the mean. Value investors argue that growth investors are exposed to a contraction of the ratio into future.
Low price of stocks is argued to be that investors are overreacting.
3 sub-styles are: High Div yield- expect stocks to maintain their yield in the future. Low Price Multiple - Expect the price to bounce back Contrarian - invest at firms selling at less than book value. |
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Describe the growth investing style.
What part of the econ cycle would growth stocks do better? Why? What 2 substyles are there? |
High expected earnings growth to drive stock price higher.
Growth stocks may do better during an economic contraction than during an expansion. This is because there are a lot of attractive stocks in an expansion so the growth premium is lost on growth stocks.
Substyles: Consistent Earnings growth - Historical record of growth is expected to continue into the future. Momentum - Has a record of high past earnings but their growth is not expected to continue into the future. |
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What is the Market Oriented investing? Is it value or growth? What are the substyles? |
A style that is neither value or growth. Basically has to beat some market benchmark or investors will just go back to indexing
Substyles: GARP - growth at a reasonable pace. Good growth prospect stocks and sell at moderate valuations. Style rotation. |
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Why do investor invest in Small or micro cap stocks? Why do some invest in large cap? |
They believe that there is less coverage on small/microcap stocks and that there is higher growth in the future. They believe that they can add value through their analysis of these stocks. |
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We partake in style identification to confirm that managers invest in the style they say they are. What is returns-based style analysis and what do the regression coefficients sum up to? What is the error variable in the regression? |
RBSA is a regression of the portfolio returns to the composite indices. We can then use the resultant coeffs to calc a custom benchmark. The error variable is due to sec selection returns. |
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In an RBSA when analyzing to indices, what properties should the indices have? |
1) The securities in the indices used in the regression should be mutually exclusive of each other. 2) The coverage of the indices should cover all the exposures of the managers. 3) The indices should represent distinct uncorrelated sources of risk.
If not, then the regression is misspecified. |
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In an RBSA, what does the Coefficient of Determination represent? What is the selection return? |
The Coeff represents the style fit or how much the proportion of investor returns explained by the indices.
The selection return is the error term in the regression. It is the difference between porfolio returns and the returns of the indices. |
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What is the logic behind the multi period Returns Style Analysis? |
A single regression gives you the results for that point in time for a portfolio. A series of regressions in different time periods will tell you the consistency of of the manager's style. |
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What is Holdings based style analysis and what characteristics do they look at? |
Evaluate the characteristics of the securities in the manager's porfolio. Look at characteristics like: Value or growth: P/e, P/B EPS growth rate: Earnings volatility: High volatility = value managers Industry representation see pp17 ss12 |
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What are the adv/disadv of Returns based analysis and holding based analysis? |
RBA 1) Characterizes and compares entire portfolios. This is the result of the investment process. 2) methodology backed by theory 3) low information requirements 4) different models usually result in same conclusions. Truly finds style 5) low cost and executed rapidly.
Disadv 1) style drift recognized slower 2) misspecified indices can lead to error
Adv 1) characterize each security. Can compare each. 2) detect style drift quickly.
Disadv 1) not consistent with how managers select securities. 2) subj classification of each sec 3) needs more data than RBSA |
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Why is it that RBSA cannot detect changes in style as fast as holdings based? |
It is because RBSA is based on historical data over time. Changes to this does not reflect in the portfolio as readily as security analysis |
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What are the 3 different ways of categorizing equity when constructing an index and assigning securities?
What is buffering? |
3 different methods of assigning securities to Value or Growth: 1) Value or Growth 2) Value, Growth, or Neutral 3) % Growth or % Neutral (style viewed as a quantity)
Note that if style is a category when building an index, there cannot be an overlap in any of the categories.
Most indices are built with no overlap though.
Buffering: When a stock is not immediately switched to another style category when its characteristics changes. This is to reduce turnovers. |
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Describe the Equity style box |
A style classification method used by Morningstar Left to right is Value, Core, Growth Top to bottom: Large to small cap |
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Categorization of portfolios differ depending on the service provider. However, style drift is of a greater concern. Why is style drift a problem for an investor and also a manager? |
For an investor, may be getting unwanted exposure. For a manager, may be getting into an area outside of his/her expertise. |
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In SRI investing, what is a positive screen and a negative screen? How does SRI affect a portfolio's investment style? |
A Positive Screen seeks out stocks that fit the SRI. A Negative screen takes it out. SRI portfolios tend to be geared towards growth stocks and also have a bias towards small cap stocks. |
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Compare a long only strategy with a long short strategy. How many alphas are earned?
What is active weight?
How can you eliminate systematic risk if you can short a port? |
In a long only portfolio, they can only buy undervalued and avoid overvalued. Earns 1 alpha.
In a long short, you can earn 2 alphas.
Active weight is how far you are away from the benchmark weighting.
You can eliminate expected systematic risk by using a pair trade. Buy one stock and short another in the same industry. |
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What are the 4 reasons for pricing efficiencies on the short side of investing? |
1) impediments to short selling reduce mgrs from shorting. Hard to borrow stock if short trade is popular
2) Firm is more likely to promote its firm's stock so stock is going to lean towards the overvalued side.
3) Analyst on sell side more likely to issue buy recommendations. There are more investors that can buy it as vs sell it.
4) Sell-side analyst faces pressure against issuing a sell recommendation. |
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Describe how to equitize a market neutral portfolio to gain equity market exposure. What are possible uses for the cash? How can you get exposure to other markets? |
Long short is a way to gain market neutrality. The positions are sized to remove any market exposures (beta).
RFR + Market return on Futures + Spread on Long short You will need to hold collateral to back these contracts. Instead of cash, you can purchase ETF's or some other exposure. Even foreign |
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What is a Short extension strategy?
What are the advantages of short extension? Disadvantages? |
It is when a manager shorts an of securities equal to a percentage of his portfolio and then purchase an equal amount of securities.
Typically both sides will have a beta will be 1.0 but the manager can choose to have a higher or lower beta.
Advantages - Perceived as an equity strategy. - Allows manager to exploit information. - Short position frees up additional funds. - (soso point) Can be implemented WITHOUT a derivatives market. - A more efficient and coordinated portfolio.
Disadvantages - More transaction costs - All value is from manager to identify under or over valued stocks |
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Define the following terms that are related to sell: (Research)
Substitution Opportunity cost sell discipline Deteriorating fundamentals sell discipline Valuation level sell discipline Down/up from cost discipline Target price sell discipline
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Substitution - Exit a security with another that has brighter prospects
OCSD - Take into account the transaction costs and tax consequences of the sale and purchase DFSD - Sell when a firm's business worsens in the future.
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What is a stock based Enhanced indexing strategy?
What is a derivatives based Enhanced indexing strategy? How can it be implement from a portfolio of securities? What are the 2 limitations profitable strategies long term? |
Stock based: Manager under or overweights secs based on beliefs. Kind of like active management but follows index to some degree
Derivatives based: Changing the portfolio using derivatives. Equitize Cash. hold a cash position and a long position in a futures contract. Can be a tool for things like alter the duration of the cash position.
Limitations 1) Successful managers will be copied 2) Models based on historical data which may not apply to the future. |
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What is the fundamental law of active management and the IR ratio? |
IR = IC * (IB) ^1/2 IC is the analyst's forecast vs actual outcomes. It is difficult to realize high IC |
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An investor has an amount of funds to invest and needs to make a series of decisions.
What are the steps and the formula to determine Utility of active return? |
1) Asset classes and their weighting 2) Passive investment is the baseline. 3) choose the amount of tradeoff & active risk and return.
(FINISH CARD) pp28
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What is the Core-Satellite approach to portfolio construction? |
The core holding is a passive or enhanced index. Complemented by a satellite of active management. Active risk is mitigated by the core and the active return is added by the satellites. The core and satellites have their own benchmark |
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What is the completeness fund approach?
What does it maximiz3 and minimize?
What is an issue with maintaining this fund? |
A completness fund usually aims to accomodate an existing portfolio by attempting to eliminate misfit risk while mainting active risk. A completness fund usually aims to accomodate an existing portfolio by attempting to eliminate misfit risk while mainting active risk.
Problem is that it must be rebalanced regularly. Also may reduce desired active return by reducing misfit risk. (U may want to invest in the style for example) |
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What is defined as a manager's Normal portfolio?
How do you use the normal portfolio to break down the components of active return? |
The Normal portfolio are the securities that a manager normally chooses for a portfolio
Investor's benchmark is his/her own BM that is usually a broad based benchmark.
True Active return: What Mgr earned relative to the correct BM Mgr Total Return - Mgr Normal Portfolio
Mgr Misfit return: Return that is from choosing a style different from Investor/Broad-based Mgr Normal Portfolio - Investor BM
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(CARD) pp 32 ss 12 sch. Do question in pp 33 Formulas for active return and True information ratio |
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What is the alpha & beta separation approach ( or the portable alpha strategy)?
What are the advantages or limitations of this strategy? |
Gain systematic risk exposure through a low-cost index fund or ETF.
Add alpha through a long short strategy. This is a portable alpha strategy.
Advantage: Gain access to asset classes outside of a systematic asset class. Better understand and manage risk. Investor gains a better idea of the costs of investing.
Disadvantage: It may be costly to implement short positions Some Long-short are not truly market neutral (Weak point) Long short may be off limits to some investors. |
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What criterea and sub criterea should we use to selecting the right investment manager?
Kind of like how a customer look at funds. |
Past Performance: No guarantee of future performance. However, managers with good previous performance is more likely to be hired.
Manager Questionnaire: Used to screen potential managers. Includes the following: 1) Management staff and organizational structure. 2) investment philosophy and procedures 3) Use of resources and how research is conducted. 4) risk management. Monitoring 5) stock selection process 6) portfolio construction process
Fee Schedule Ad valorem: Based on AUM. Can be tiered Performance fees: High watermark prevents a manager from collect feestwice on
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What are the adv and disadv of Ad Valorem fees and Performance fees? |
AUM fees are straightforward and known in advance. Disadv: they don't align management interest with investor. Performance fees have 2 disadv. Complicated/ requires detail specifications. Increases the volatility of the manager's compensation. However they align interests if the interests are symmetric. |
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Why would using a value weighted index less advantageous than using something like a P/E ratio index at times? |
It is because a value weighted index may contain a lot of stocks that are fully or overvalued as compared to if we take earnings into considerations. |
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Why are investors risk adverse when faced with active risk? |
1) the investor must first accept active return is possible 2) Investor must believe they can find the right active managers |
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In returns based style analysis, you can compare an index that is separated into value and growth or maybe add a neutral field. What are the general difference in results from using less or more fields? |
If you use a more "granular" set of indices, it will likely better explain the portfolio style and as well obtain a higher Rsquared. |
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Even though many portfolios are long-only portfolios, how are these disadvantaged compared to a long short portfolio? What is the added risk? |
1) Prevents a manager from exploiting the short side of a stock. 2) Not going short prevents a manager from fully exploiting the long side. The added risk is the unlimited loss possible in the short side. |
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Are the sizes of Long alphas or Short alphas bigger? Why is this so? |
The short side usually has bigger alphas because: 1) Shorting is more cumbersome which means it has limited use. 2) Sell recommendations from analysts are uncommon. 3) Analysts are likely not to cover a stock they don't like. 4) Analysts working with investment banks usually have strong incentive not to recommend sell. |
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(Research if synthetic approach to e indexing) What are the advantages in using stock based enhanced indexing or the synthetic approach? Real ingredients is great bread. Synthetic is just straight and no culture. |
Stock indexing is built LIKE the index with some over or underweight. Tries to outperform on a regular basis. Adv is that it has greater breadth.
Synthetics tend to use futures or swaps and tends to be in fixed income. It has the advantage of being straight forward. |
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Is the information ratio maximized from passive, semi active, or full blown active? |
Maximized at semi active. |
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What is the difference in objective between core satellite vs completeness fund? |
Completeness fund seek offset what the investor already has to achieve index like characteristics. |
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What is misfit risk? |
The difference between manager's normal portfolio and the benchmark portfolio. |
