7. (+4) FUND MANAGEMENT Flashcards
ACTIVE SHARE
=[ SUM (Abs diff between weightings in portfolio vs BM)] /2
used to calc degree of active management
tracks disaparity between fund holdings and BM
low active share indicates close replication of index
Tracking error
Indicator of how actively fund is managed
measure of the risk in an investment portfolio that is due to active management decisions made
Max drawdown
Max peak to trough drop as in investor entered @ top and exited @ bottom
= bottom/top - 1 (%)
Active Bond Strats
Duration switching - changing portfolio duration in expectation of rising/falling rates. Rates down = bull market = increase duration (switch low D bonds for high) Rates up = bear market for bonds = reduce duration
Riding yield curve = sitting on curve - buying long dated and riding then selling before maturity and profit from declining yield over time (upwards sloping curve, price pull to par)
Buy beyond investment horizon + sell @ end of period
Bond switching
- policy switching - switch between disimilar bonds to take adv of anticipated changes in IR, yield curve, credit rating, sector, tax etc
- anomaly switching - switch between bonds with similar characteristics (duration/mat/coupon) but whose price/yields are out of line with eachother - will have to weight if there are big differences in duration. 1 for 1 = basic substitution swap
pure income yield pick up = selling stock with low yield and buying high (same JGRY)
-intermarket spread switch - capitalize on discrepancies in yield between bond sectors e.g. HY/IG, corp vs gov
HY bonds naturally less rate sensitive because duration lower
Passive bond strats
Cash flow matching/dedication - bonds purchased to match liabilities as they fall due, simple, can use coupon payments, T bills, gilt strips
Immunization/duration matching - buying portfolio of bonds with duration equal to any liabilities to immunize portfolio against IR movements - must constantly adjust portfolio composition
Multi period immunisation = complex funds w/multiple liabilities - match duration of diff bonds to various liab. PV of assets should be greater/=PV of liabilities
Barbell - invest in series of secs with more than one maturity - short dated and long dated. longer dated = higher attractive yield and short dated creates reinvestment ops
Ladder - buying secs with varying maturities - series of maturities provides options for withdrawal/reinvestment - reduces sensitivity to IR risk. Lock in sec of shorter dated and higher return of longer dated
Focused/Bullet - bonds with maturities/durations close to that of liability
Horizon/Combination matching - part CF matching part immunization hybrid - CF match early liabilities (12m) and immunize at average duration for remaining investment horizon.
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
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
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
Beta investing
Aim to identify stocks with potential to realise large price fluctuations (eg B>1)
more aggressive/high risk/reward
low B investing is more conservative - focus on capital presi and downside risk management
timing of investment into high stocks when market is poised to go up
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
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
Quant analysis/funds
Use algorithmic investment strats programmed to make investment decisions - often high freq trading
- algos price and manage complex derivs and use stats to determine which shares are relatively expensive/cheap
- often leverage used to enhance returns and mispricings may be small
- programmes rely on thousands of trading signals
Quant funds
- uses predetermined/pre set models to undertake investment selection
- account for large portion of HFs - large growth but many of these direct trades into same positions
Stat arb utilises mean reversion in pairs tradition of highly correlated secs and spots ops where prices have drifted
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
- 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
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
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
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
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
Buy and hold
Buying stocks and holding for long period regardless of fluctations in market
easy and cheap
no advice or trans costs
no concern for short term movements
relies on initial analysis on purchase but doesnt respond to changes in market
Indexation
Passive approach where portfolio closely matches that of a BM
elimates the diversifiable risk of buy and hold
Duplication/complete indexation
all constituents in exactly right weighting
no TE in theory but have to rebal and lots of trading costs
complicated and expensive to yourself if too many constituentsS
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/optimisation
To reduce costs - only sample portion of index
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
Factor matching
Mirroring factor values from index with difference secs
e.g. avg PE ratio, divi yiled etc
Could use divis to replicate performance
Fama and french approach would be more of a factor matching approach
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
Factor investing
Factor investing is a strat that involves choosing secs on attributes associated with higher returns
attributed of the STOCK not the COMPANY
e.g. beta, value, momentum, vol
factors exhibit cross correlation which could lead to overlaps and unintended risk concentration
Comingling
Compromise between trans costs of complete indexation and tracking error of stratified sampling
describes portfolio comprising multiple unit trusts/OEICS/ITs blended together
suitable for smaller portfolios
Relative perf of value vs growth
Correlated well with changes in corp earnings - earnings up, value tends to perform well from a low base
when corp earnings momentum slows, growth outperforms as managers favour comps with greater potential for earnings recovery
Unusually low rates have led to outperformance of growth in last 15 yrs - with rates close to zero attractive to take longer duration equity risk
rates 22 - tech stocks plumet and value outperforms, war in ukraine compounds this. regional banking crisis 2023 hit financials - important value component
mag 7 and nvidia driving growth momentum into 2024
5 phases of wealth management
Fund objectives -
Investment philosophy
Fund strategy
Asset selection
Perf eval
Maximizing returns for specific level of risk
Client risk pref - ratios between assets, client circs (time horizon, need and ability to take risks, liquidity, tax position, restrictions), beta/durations of equities/bonds, portfolio exposure to systematic risk, currency and liquidity of UL
Currency risk - can take active steps to hedge risk with futures/swaps, currencies fluctuate a lot over LT - macro (inflation, rates, stability). Can also purchase hedged share classes. Currency risk can be significant in MM/low risk assets due to: lower return potential (big impact), long term horizon
Liquidity constraints - short term liquidity reqs, funds will have a requirement to meet need for liquidity in certain circs
TIme horizon
Liability matching
Tax status (domi/resi)
Legal and ethical reqs
DB vs DC pensions
Pension funds = tax efficient pool of savings to be invested
DB = defined benefit/final salary (or career average)
- amount paid depends on length in scheme and salary earned when you leave/retire
- pay out secure income for life which increases in line with inflation
- most closed to new members, unpopular with employers as they have to cover any deficit between actuarial estimates of the sum required to meet future payments and how much is available in the pension fund
DC = defined contribution/money purchase
- essentially an investment savings pot for each individual scheme member
- most common type of workplace pension now
- at retirement, sum invested (+ any returns) is used to generate income either from investments or with annuity purchases
Longevity risk on a DB scheme lies with the fund but for a DC pension it’s with the individual
Low gilt yields have put pressure on DB schemes (ass has increased life expectancy) because discount rates used to value liabilities were v low so the PV of liabilities grew faster than fund assets but rising yields have reduced this pressure
Fund manager selection
Past performance/consistency - against benchmark but also vs factor/style and peer group. Sharpe ratio
Consistency of management personnel - experience on strategy, at fund house, in asset class etc
Process/style drift - drift in strat if style is out of favour, renaming, changing BM
Internal risk and control measures - internal liquidity constraints, position sizing etc, size and independence of auditors
Admin
Dealing
Fund strategy
Manager compensation
Location/regulatory oversight
Tax domciile
Reporting status
Succession planning
fee structure - increasingly, high fees challenged given advent of passive investing
Fund management specialisations
Ethical/socially responsible investments
Macro strats - use derivs (IR swaps, swaptions, CFDs, FX swaps/forwards, TR swaps, options, futures) to gain exposure to wide variety of asset classes - many HF macro strats
Quant/quali approached - quant associated with computer algos that analyse data and generate both ST and LT AA decisions
Quali - manager skill/judgement/market knowledge to determine asset (classes) that will achieve either SAA or TAA
FX issues - to hedge or not? Do you want exposure to currency, if no still may not hedge as hedging is expensive. What is directional view on each currency. may win on stock/fund and lose on currency or vice versa
Investment stewardship
Refers to manager looking after assets as steward on behalf of other stakeholders - rather than seeing themselves as a ST trader
Stewardship is the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society.
No wide agreement on what stewardship is
More to stewardship than just engagement/voting (roundtables, industry collabs etc)
RDR
Retail distro review - 20212
RDR required advisors to raise knowledge to a level 4 diploma quali
Banned UK advisors from receiving product commission for retail customers in UK
Customers had to pay for investment advice they received
SMCR
Aims to raise standards of governance and increase individual accountability
Applies to all FSMA auth firms
2 parts - SMR and CR
SMR = focuses on most senior indivs who hold key roles/have overall responsibility
firms must ensure each SM has a statement of responsibilities they are personally accountable for
FCA is very keen to be able to apportion responsibility for a regulatory failure to those in positions of authority within firms.
CR = applies to material risk takers
- any staff who have a significant harm function to company/customers or any staff subject to dual regulated firms remuneration code
Consumer duty
Intro in 2022
aims to set higher and clearer standards of consumer protection across FS firms
promotes responsible behaviour
fosters culture of client focused service
UK corporate governance code
Published 2018 with various updates
regulates company not investor
set of Principles that emphasize the value of good corporate governance to long-term sustainable success
Sets out standards of good practise in relation to 5 areas
- Board leadership and company purpose
- Division of responsibilities
- Composition, succession and evaluation
- Audit, risk and internal control
- Remuneration
Operates on a comply or explain basis
18 principles (new principle added to 2024 version)
Mandatory for fully listed comps on LSE to explain how they have applied principles in their annual report
Corp gov code and stewardship code together
designed to be two sides of same coin
FRC sees common thread between two
no stewardship code = nothing to bind listed companies to the governance code
stewardship code encourages investors to examine credibility of comps explanations/justifications in corp gov code
in gov code - LT SH = key stakeholder
LT returns to SH are key objective of company
directors of comp should enter dialogue with SH so they can hear their views and run company in their interests
UK Stewardship code
2020 - sets high stewardship standards for those investing money on behalf of UK savers and pensioners ( or support them)
Applies to UK companies not overseas investors that own UK shares
Applies exclusively to investment managers and not other entities in investment chain
Applies to asset owners (pension schemes, insurers, foundations, endowments), asset managers (who invest on behalf of UK clients or in UK assets) and service providers (e.g. consultants, proxy advisors, research providers)
comprises of 12 apply and explain principles for asset managers/owners and 6 prins for service providers
voluntary but once you sign you must adhere
4 sections
- purpose and governance, investment approach, engagement, exercising rights and responsibilities
Voting
Voting rights can be powerful way to send message to corporate directors
Instit shareholders under increasing pressure to vote shares tho not a legal requirement
Ways to register dissatisfaction with votes
- withhold/abstain
- vote against reelection of one/more directors
- vote for appointment of alternates
Voting and stock lending
Lending = essentially a full sale and buy back so all voting rights attached to shares are transferred but lender retains financial exposure to shares since they are returned@end and any divis reimbursed
Lending generally increases around divi announcements/votes
Can state intention to recall shares in order to vote them but this makes people less likely to borrow as often voting is part of the reason borrower wants shares (so people rarely do this)
FMs should disclose lending and recalling policy as must weigh ability to generate income from lending against loss of ability to discharge stewardship activities
oversight and engagement
Voting can be more effective when part of ongoing engagement with comp/board - w/out this the voting is anon and reported as summary stat
May not have resource to engage with all investee comps
important tht engagement is timely as less likely to be ignored
Divis
FMs may be dissatisfied if divi deviated more than expected/guided
can express by communicating with board/finance director/voting to replace directors
bond covenants can restrict asset sales to fund extra ord divi payments
Info disclosure
Regular and timely reporting can prevent fraud and mismanagement
Helps stakeholders determine risk profile and estimate comp value
Reduces potential for info disclosure to differ markedly from expectations
Litigation - direct and indirect
Direct = SHs who were harmed, indirect = corporation harmed
Class action: direct litigation
- 1/more Shs/reps bring lawsuit against comp onn behalf of other SHs of same class
- Principal aim is usually financial compensation
Secs class action - usually in response to large sudden drop in share price in response to negative unexpected news
- brought by those who suffered loss as result of purchasing @ earlier price that reflect misstatement/overly optimistic announcement
- claim = vio of secs law that seeks to protect investors from reporting irregularities/misleading/inaccurate info and inadequate risk management and oversight
Derivative/indirect litigation
- comp files claim against 1/many of its own officers/directors
- focuses on removal of conflict of interest, director appointment, terms of contract, remuneration, share valuation, terms of proposed takeover, acquisition/disposal of assets
Myners principles
UK gov commissioned Paul Myners - carry out review of investment decision making in UK pension schemes 2001
made recs known as Myners’ principles (6) - encourages adoption of best practice
Effective decision making
- trustees are central to this, should have in house support and out of house consultants, recommends investment subcommittees
- trustees should have necessary skill and should spend more time on AA decisions and consider all asset classes
Clear objectives
- investment obj should be relevant to scheme and communicated to all managers
-should relate to fund’s liabilities (not perf vs peers/benchmark) - liabilities should be basis of investment policy
Risk and liabilities
- Awareness and understanding of risks and tolerance in the funds managed
Perf assessment
- Formal assessment of management + trustees/board/IMs/consultants
Responsible ownership
- trustees should have policy to discharge resp as investor (voting, monitoring, intervention)
- trustees should use SH power to intervene when appropriate in running of comps they invest in
Transparency and reporting
- keep mentors and stakeholders informed with regular comms
