A. Portfolio Management: An Overview Flashcards
Defined benefit
An annual amount
Defined benefit pension plans
Companies pay employees a defined benefit. Companies bear the investment risk.
Institutional Clients
Defined benefit pension plans Endowments and foundations Banks Insurance companies Investment Companies Sovereign Wealth Funds
Endowments and foundations
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Banks
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Insurance Companies
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Investment Companies
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Sovereign wealth funds
Bonds???
The first steps of the portfolio management process
Understand the needs of your clients
Create an investment policy statement
Second steps of the portfolio management process
Security Analysis
Portfolio Construction
Monitoring
Performance Measurement Stages
Investment products to use in portfolio creation
Mutual Funds
ETF’s
Hedge Funds
Private Equity Funds
The financial needs of defined benefit pension plan investors
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The financial needs of endowments and foundations
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The financial needs of banks
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The financial needs of insurance companies
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The financial needs of hedge funds
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The financial needs of Investment companies
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The financial needs of sovereign wealth funds
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Defined contribution pension plan
Contributions are defined by the employee and company. The employee bears the risk.
Mutual funds
Professionally managed investment pool
Investors: pro-rata claims on income and value
Pooled investment products
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Portfolio approach provides investors with a way to reduce the risk associated with their wealth without necessarily decreasing their expected rate of return
Evaluating individual securities in relation to their contribution to the investment characteristics of the whole portfolio
What do portfolios offer?
Equivalent expected returns with lower overall volatility of returns
A measure that represents volatility of returns
Standard deviation
Standard deviation
A measure of dispersion in the same units as the original data
The positive square root of the variance
The probability weighted average
The expected value
Variance
The expected value (the probability-weighted average( of squared deviations from a random variables expected value
Dispersion
The variability around the central tendency
Volatility
The standard deviation of the continuously compounded returns on the underlying asset
Trade off between risk and reward in laymens
Return per unit of risk
Invest shares as equally weighted in laymens
Invest the same dollar amount in each security for each quarter
Equally weighted portfolio returns are the average returns of the individual shares and
The SD of an equally weighted portfolio is not simply the average of the SD of individual shares
Equally weighted portfolios
Returns are averaged but SD’s are not
Critical ideas about portfolios
Portfolios affect risk more than returns
Portfolio characteristics
Help avoid effects of downside risk associated with investing in a single companies shares
A simple measure of the value of diversification
Diversification ratio
Diversification ratio
Calculated as the ratio of the standard deviation of the equally weighted portfolio to the standard deviation of the randomly selected security.
The diversification ratio of the portfolios SD to the individual assets SD meausures…
The risk reduction benefits of an equal weighting method
Simple portfolio construction method
Equal weighting
Lower diversification ratio indicates
Greater Risk reduction
The composition of portfolios matters
Rather, the risk to return profile
Portfolios aren’t necessarily for downside protection
Because correlations and complements can move out of the investors favor so diversification benefits may be small a la 2009. Rather, diversification does not provide the same level of risk reduction during turmoil.
Why do portfolios reduce risk?
Because combining securities whose returns do not move together provides diversification
Risk reduction
Aka volatility reduction
