3 - INVESTMENT PLANNING (fin.) Flashcards
IPS should include
Investment objectives
- standard wording, growth, income, balance
-any specific goals
Client circs
- needs, restrictions, base currency, liabilities, residency
Risk profile
- set out risk profile, capacity for loss, attitude to risk, views on vol/drawdown
Liquidity reqs
- known liabilities, external cash
Time horizon
Tax position
-residency, tax wrappers, pension drawdown, losses carried forward
Investment strategy
- should be adopted to meet needs and set out - direct, funds, multimanager, cost, active/passive
- sentimental holdings/avoidances
Asset allocation
- permissible assets and target AA + any constraints
Constraints
- eg ESG reqs
Benchmark
Reporting frequencqy
Investment solutions
Funds = mutual funds or managed solutions
- return focused = income/growth/balanced. Meet or beat index
- risk targeted = vol constraints while maximizing returns
- multi manager = FoF or MoM
DPS - portfolio managed on behalf of client either with model portfolio or bespoke
Advisory management
XO - can provide a preferred fund panel for these clients
What are manager of manager and fund of fund strategies
FoF = assets invested in other collective funds to utilize the expertise of asset managers on each asset class
- one overall PM that invests in portfolio of other funds
- fettered FoF = invests only in funds managed by same group (reduced double charging and increased understanding of funds but a bit dodgy)
- unfettered FoF = invests in any funds - wider degree of diversification
MoM = assets managed by specialized managers in each asset class on segregated basis
- fund arranges segregated mandates and appoints FM they believe are the best
- usually large initial investment reqs
- long time to change disappointing manager
important for both
- what AA - conventional or HF/commodities too
- active vs passive vs blend
Advantages and drawbacks of MoM vs FoF
MOM
Gives access to instit managers retail usually wouldnt access
Can replace indiv if manager underperforms - dont have to sell units so avoids switching costs
Can be cheaper - instit tents to have lower fees
Portfolio can be over diversified turning into closet expensive tracker
May not be able to access best managers at other firms as they dont want PMs to be distracted whereas FoF can access whatever they want
Long time taken to replace disappointing manager whereas FoF can just sell
Discretionary investment managerment
For wealthy indivs = services vary widely
Manages portfolio without ref to client but within constraints of client’s risk profile and investment objective
Can be model portfolio with standardized portoflio around range of risk profiles
Bespoke - tailored to each indiv client
Advisory = for clients that dont want to give up decision making entirely - PM considers changes and then consults with client who has final authority
Centralised investment propositions
Model portfolios (MPS)/portfolio advise services = model portolio to meet investment reqs of client, often smaller amounts
DIM (in house or outsourced) - where advisor has input into strat
DIFs (distributer influenced funds) - typically OEICs where advisory firm exerts measure of control over fund and management - advisor gets comish for selling fund, potential conflict FCA doesnt love
FCA doesnt want one size fits all product
Steps in structured AA process for a client
- evaluate needs and ATR
- assumptions about future expected returns, risk, corr of asset classes
- select combo of assets that match objectives and risk profile to give min risk for expected level of return
- establish LT SAA - reflecting LT optimal mix of assets
- implement ST TAA - decisions against SAA backdrop
- periodic rebalancing to bring inline with SAA (tax and trans costs)
- reviewing SAA periodically to ensure continued suitability
SAA
Widely used approach is SAA with TAA overlay
SAA is
- relatively static
- usually set using proportions of externally recognised global BM
- peer group/fund compositions
- extensive risk/return numerical data
infrequently changed and reflecting a ‘neutral’ LT position
Usually managers given permitted range to operate within
diversified within and across asset classes
be suitable for client risk profile/needs/circs/time horizon/liquidity needs/liabilities/ESG preferences
TAA
Often used as an overlay to SAA - TAA considered relative to the long term strategic benchmark
Purpose = systematically exploit inefficiencies/temp imbalances in values between asset classed
chasing alpha by ow/uw asset classes from their LT SAA weight
taking advantage of short term market movements, developments
more frequently adjusted - monthly/quarterly
May use derivs to provide tactical overlays given the shorter time period - can deploy rapidly and cost effectively (cheaper and quicker)
Tactical bullish/bearish strategies
FI
Equities
Tactical
Derivs
TAA implementation is complex
Often TAA committee can be slow
Requires correct interpretation of noise
Active equity strategies
Active = careful selection/timing of investments - often mandated to beat index benchmarks using skilled analysis
Value investing
Growth investing
GARP
Momentum
Technical analysis
Fundamental analysis
Quant funds
Top down
Bottom up
Quality
Beta investing
Top down vs bottom up
Top down = assessing macro factors and using that as an input to AA and then stock selection
- economic growth, GDP, employment, business cycle, rates
Bottom up - strategy starts with unique attractions of individual stocks. benchmark agnostic
economy taken into account often as overlay
often there is a combination of the two
Value investing
- Focus on stocks that appear to trade for less than their intrinsic book value
- established comps, often cyclical, which have been underestimated by market (oversold/out of favour) so can purchase @ discounted price + should return to intrinsic val
- may focus on shares with low PE among other metics (low price/book, high book/price)
- provides margin of safety against further derating
- seek to avoid value traps where shares are cheap for a reason that can trigger permanent losses (may get sucked in with divi)
- belief indiv secs will revert to fundamental/intrinsic value + that market overreacts to bad news
- requires LT horizon usually for market to recognise stock is undervalued, ST underperformance can arise
focus on recovery/mean reversion differentiates from growth investing
Graham 7 tests for value investing
recs for tests to be carried out when stocks are identified for inclusion in defensive portfolio
ADEQUATE SIZE = smaller comps = susceptible to wider fluctuations in earnings so min size rec based on turnover e.g.
STRONG FINANCIAL CONDITION - current ratio of 2+, LT debt shouldnt exceed working capital to provide strong buffer vs bankruptcy
EARNINGS STABILITY = no losses reported in last 10y (maintenance of earnings implies some stability)
DIVI RECORD = history of 20+ years for assurance of future divi
EARNINGS GROWTH = to ensure profits keep up with inflation - net inc should have increased by 1/3 or more per share over last 10y
MODERATE PE RATIO = below 15x avg L3y earnings to safeguard vs overpaying
MODERATE PRICE/ASSETS RATIO = not >1.5x book value of assets
Growth investing
Focus on shares whose earnings are expected to grow in the future
- often smaller/younger comps poised to expand and increase profitability
- competitive adv with insulated earnings
- lower/no divi vs value as earnings reinvested
- look @ margins/ROE, share price perf, historical and future earnings growth
- often trade at higher PEs, higher risk and can have limited track record but potentially higher retirns
- Growth stocks will sell off if earnings expectations are missed as value is based on these future earnings so forecasts must be rigorous
GARP
Less aggressive than growth - reasonable PE is equal/below annual earnings growth rate = PEG ratio (PE/annual EPS growth) <1
- other protective valuation measures include divi cover, borrowings and liquidity
- combines tenets of value and growth to select indiv stocks w/ above avg earnings but excluding those too richly valued
Blend
Combines value and growth stocks or stocks with traits of both
Growth may have potench to exceed returns of market but more vol than value stocks - good when economy doing well
Value may outpace in certain economic conditions eg 2022, recovery periods etc
Blend investors can ow whichever style is in favour based on cycle
Arg against is that most successful FMs have had specific style
Income investing
Identifying comps that provide steady stream of income
- often have reached size that cant sustain large levels of growth so pay out earnings rather than retaining to fund growth
- can be prominent in certain industries eg utilitites
- sustainably high divi yield, steady predictable income streams, fundamental analysis to ensure divi growht
Momentum investing
Aggressive version of growth - focus on comps whose share price has been rising and who continue to gather momentum
- momentum investors profit from ST trades vs growth with is LT
- risk is upwards trend wont last forever, exiting early or late can erode returns
Fundamental vs technical analysis
Fundamental analysis = measures secs intrinsic value using publicly avail data. conc of macro and micro economic metrics
view to forecasting future profits and determining fair value/mispricings
Technical analysis = looking @ patterns of price and volume to anticipate market/directions
developing support and resistance price targets for secs
belief info is priced in so no merits in studying the fundamentals
self fulfulling as you reactively sell in response to sell signal and price declines
inverted head and shoulders pattern = bullish price pattern
Quality
Selecting comps with outstanding/clearly defined quality characteristics
both soft (management credibility) and hard (metrics, high ROE)
financially health with strong balance sheets
Low leverage (debt/equity), earnings stability, high ROE
strong financials, consistent earnings, a competitive advantage, and a solid track record
BENE AND LIMITS OF ACTIVE MANAGEMENT
Active = managing a portfolio to achieve greater returns than those of index benchmar
BENE
- can tailor strat to meet specific goals
- allows specialist investment strats
- have potential to generate better performance relative to benchmark index over time post fees
- investors have flexibility to choose assets that they believe will outperform
- many active managers are supported by big team of analysts = extensive research to find investment ops
DRAWBACKS
- better performance not guaranteed, can lag benchmarks
- many fail to beat benchmark consistently over long periods tho there are exceptions
- can be hard work and time consuming
- fees can be high which has compounding effect over time, an have exit and perf fees
- top managers can be selective as to who they take on and may have high initial min thresholds
- some actively managed funds are closet trackers
WHAT IS PASSIVE
BENE AND LIMITATIONS
Passive = No attempt to distinguish between secs/activeness/value/research - assets allocated across constituents of an index/representative sample. Passive because no decisions on securities made.
Based on belief it’s not possible to consistently beat index on a risk adjusted basis
BENE
- lower fees (reduced marketing, distro, accounting, investment costs) - ETFs mos popular
- liquid
- v transparant, clear which holdings are in portfolio
- frequently rebalanced, so investing in passives requires minimal trading
- wide variety of indices avail to suir broad range of styles
-common ETF structure means they are more tax efficient than mutual funds
LIMITATIOS
- when adjusting portfolios to reflect constituent changes, may end up over paying when buying and selling @ depressed prices
- cash drag and internal costs can effect perf and cause tracking error
- can be overly concentrated - vulnerable to political/regulatory events
- buy and sell decisions based on index not on research
cannot outperform index
- cash drag and internal costs can cause tracking error
Passive equity strats
Buy and hold
Indexation
- Duplication/complete
- stratified sampling
-Factor matching
- smart Beta
-optimization indexation
-synthetic indexation
Comingling
Impact of TE
index constituents changes = sec drops out of index and price falls as result, investors forced to sell and overpay for new additions
Could underperform an index due to this which is dangeorus since point of passive funds is to match index
can get -ve alpha after costs even tho same risks taken as market
Duplication/complete indexation
all constituents in exactly right weighting
no TE in theory but have to rebal and lots of trading costs
complicated and xpensive to yourself if too many constituents
Only suitable for very large portfolios
Why does full duplication index fund have TE/active share
Transaction costs that occur when constructing/rebalancing/changes in index comp/investing divi received
Timing of buying/selling stocks when they leave/enter index
Round lot purchase reqs which may mean difference in no. of stock in fund vs index
possible restrictions on foreign ownership if index is not domestic only
Change in price due to entering/leaving index - fund may trade after event
If index is TR - assumes ex divi date is payment date when it is usually weeks after
Cash drag - delay between when an ETF receives a dividend and when it uses the proceeds
Stratified sampling/optimization
To reduce costs - only sample portions of index from each sector
Lack of statistical analysis means method is subjective
Home/familiarity bias could create a problem - excluding new growth comps
essentially taking sector cross sections - hold sample of index that represents characteristics of index
based on key metrics like exposure, risk, and correlation
Can create bias towards stocks with best perceived growth prospects
Optimization = uses sophisticated modelling to find representative sample of secs that min the broad characteristics of index tracked
Smart beta
passively follow indices, while also considering alternative weighting strats such as volatility, liquidity, quality, value, size and momentum(not passive)
- e.g. equal weighted, low vol, divi focus etc
Goal of smart beta strats= generate alpha/lower vol/diversification @ lower cost vs trad active management
combines benefits of active and passive
smart b funds use rules systematic approach to choosing secs from an index
Smart beta
passively follow indices, while also considering alternative weighting schemes such as volatility, liquidity, quality, value, size and momentum(not passive)
Goal of smart beta strats= generate alpha/lower vol/diversification @ lower cost vs trad active management
combines benefits of active and passive
smart b funds use rules systematic approach to choosing secs from an index
Synthetic replication
FM enters into swap to exchange returns of index for payment
Samling used to identify optimal range of secs to be included
TE and rebal risk passed to counterparty - ETF generates exactly the performance of an index
Generally the loest cost method
Cash from investor purchase used to buy basket of collateral, variable returns of collateral swapped for returns of index with counterparty
unfunded vs funded swap model = funded swap model collateral does not have to track BM index and assets may be different (tho likely correlated)
Can have high TE vs physical
Useful more markets that are usually hard to access
Investor is exposed to counterparty risk - need to understand how this is managed
SDGs
Collection of 17 interlinked global goals adopted by all UN member states in 2015 - call to end poverty, protect the planet + ensure peace and prosperity for all by 2030
UK sustainability regs
Climate related disclosures must be consistent with TCFD reqs by law
SDR - introduces specific sustainabilty related product labels and reporting reqs in attempt to increase transparency and reduce greenwashing
