CH:17 Investment management

Question 1

Explain tactical asset allocation

Answer 1

involves a short-term departure from the benchmark position in pursuit of higher returns

Question 2

What needs to be considered before making a tactical asset switch

(4)

Answer 2

• expected extra return compared with additional risk
• constraints on changing portfolio
• expenses of switching
• problems of switching large amounts of assets
• tax liability of capital gains on selling

Question 3

Explain risk budgeting

Answer 3

process that establishes how much risk should be taken and where it is most efficient to take the risk (in order to maximise return)

Question 4

Describe the three main components of a risk budget for investment risk

Answer 4

Strategic risk - Risk of poor performance of strategic benchmark relative to the value of the liabilities

Active risk - Risk of poor performance from fund manager relative to a benchmark

Structural risk - Mismatch of aggregate portfolio benchmark and total fund benchmark

Question 5

Portfolios are constructed to meet 2 main objectives

Answer 5

1. ensuring security
2. achieveing high long-term returns

Question 6

Why is it necessary to review the continued appropriateness of any investment strategy at regular intervals

Answer 6

• liability strcuture may have changed
• funding or free asset position may have changed
• managers performance may be out of line

Question 7

What is historical tracking error

Answer 7

annualised standard deviation of the difference between actual fund performance and benchmark performance

Question 8

What is forward-looking tracking error

Answer 8

involves modelling the future experience of the fund based on its current holdings and likely future volatility and correlations to other holdings

Question 9

What are the 2 methods for measuring the performance or rate of return on an investment portfolio

Answer 9

• money-weighted rate of return
• time-weighted rate of return

Question 10

Expain money-weighted rate of return and its limitations

Answer 10

identical to the concept of an internal rate of return: it is the discount rate at which PV of inflows = PV of outflows

Limitation
* Assuming a MWRR is calculated over many periods, the formula will tend to place a greater weight on the performance in periods when the account size is highest

Question 11

Explain time-weighted rate of return

Answer 11

Compound growth rate of 1 over the period being measured. No account is taken of flows of money into or out of the portfolio.

learn how to do TWRR