Chapter 13: Investment Consulting Flashcards
Describe the term ‘fiduciary management’.
Fiduciary management
This refers to the situation where the investment consultant takes over all or much of the management of the asset portfolio from the trustees of a pension scheme (or other fund sponsor).
The duties may involve all or some of the following:
* hiring and firing existing fund managers
* researching potential fund managers
* drawing up investment mandates with each manager
* monitoring performance and arranging the payment of fees
* designing suitable benchmarks or the investment strategy
* altering the investment strategy.
The assets may be managed by a ‘manager of managers’ rather than awarded directly to specific fund managers. Manager of managers run funds that are managed by the ‘best in class’ managers.
Describe the terms:
* core-satellite
* fund of funds / pooled fund
Core-satellite:
This means that a large part of the funds to be managed will be invested through a passive fund manager in each of the asset classes that have been chosen.
If active management is considered to be worthwhile in that asset class, a satellite active manager may also be involved to add alpha.
The result is a similar risk and return scenario to employing a balanced manager, but at significantly reduced costs.
It may be useful for larger funds where active management is difficult due to deal size.
Fund of funds:
This represents pre-selected combinations of one or more investment managers’ funds into a coherent whole, overseen by another investment manager or a consultant.
It may be referred to as a ‘manager of managers’ arrangement.
It is particularly useful for specialist areas (such as hedge funds) or where the fund is too small to benefit from the best in class managers directly.
List the issues that should be considered when selecting an active manager, split into ‘shallow narrative’ and ‘deeper narrative’.
(#SAME PICK)
Shallow narrative:
The past performance of the manager.
this is the most common form of fund marketing, but conflicts with the idea that past performance is not (and has not in the past) been a good guide to the future.
It therefore represents a shallow narrative.
Deeper narrative
(#SAME PICK)
* What Strategy or style did the manager pursue, and was it constant throughout?
* How has Available information changed?
* What Market Environment existed over some or all of the track record?
* Was the manager’s Personnel stable, including responsibilities or how they might be Incentivised?
* How has market Competition changed over the period?
* What role have Key people had during the peri
List other factors, not in the Core Reading for Subject SA7, that might influence the choice of active fund manager.
Other active manager issues
- Whether the fund manager is owned by a larger parent
- Whether the manager accepts small fund sizes
- Whether the manager accepts all types of mandate and target
- The quality of the back office and the client service personnel
- The risk control, middle office and compliance efficiency
- The track record and employment records of the fund managers
- The source of research (Internal or external)
- The recent growth (or contraction) of funds under management
- Incentive packages for staff
- Turnover of staff in recent years
- Numbers of staff in key areas or front office
- The processes used by the manager to gain an advantage over competition (for example style bias, fundamental analysis, technical analysis, …)
- Client turnover in recent years
List three ways to communicate levels of risk to clients.
Three ways to communicate levels of risk
- A descriptive method:
describing the risks largely in words, possibly in combination with a historical quantitative measure - historic quantitative measures:
presenting risks using eg historical standard deviations and correlations applied to the client’s portfolio - risk ratings:
a relative (sometimes prescribed) classification system for drawing attention to higher or lower areas of risk.
List four main difficulties encountered when communicating risk.
(#RICI QQ)
Four difficulties encountered when communicating risk
(#RICI QQ)
- relative risk Rating vs Impact of risk:
to what extent a simple rating system can properly capture non-linear impacts. - Consistency:
how to ensure that the same words mean the same thing when used by different consultants or for different clients - level of Information:
how much detail to provide before the information becomes difficult to assimilate and understand - quantitative vs qualitative:
whether to emphasize numerical results (which are likely to be based on a risk model, that may have inherent weaknesses) or a more subjective explanation of the risks and circumstances that could give rise to adverse outcomes
Describe the two main criticisms of fiduciary management (or implemented consulting).
Two main criticisms of fiduciary management
- Consultants are incentivised to expand the scope of their services and the complexity of client portfolios through the addition of fiduciary management services.
So, for example, if the consultant can convince the client to expand into hedge funds and overseas property, the consultant’s fees may well rise due to the complexity of the markets.
Likewise if the client’s assets are invested in a more active manner, reducing the passive fund proportion, then the consultancy fees will rise.
- Fiduciary managers generally make significant use of internal funds, which could be directly managed or follow a fund of funds approach.
This restricts the ability of investment managers to market their funds directly to such clients (ie it cuts out the competition).
Outline six services that a performance measurement company can offer to clients.
(#ALARM E)
Services offered by performance measurement companies
(#ALARM E)
- Absolute performance measurement figures, both for a whole fund and/or for individual asset categories or individual investments
- Long-term performance statistics.
- Attribution analysis
- performance Relative to an investment index, a notional benchmark fund, and a specified universe of other funds (depending on relevance)
- Measures of investment risk including risk-adjusted performance measures
- Explanations of how the relative performance was achieved
List six negative factors from SA7 and SP5 that become issues when a manager’s performance is actively monitored and reported.
(#C SPORT)
Six factors concerning performance measurement
(#C SPORT)
- Costs of measuring the performance are borne by all parties
- Short-termism can be a consequence
- Past performance is not a good guide to the future
- Objectives may be different from the peer group, or there may be constraints on the manager that do not impact the peer group of the index against which he or she is measured
- Risk levels may be different making the comparison invalid
- Time scales:
it is important to monitor frequently enough to catch changes,
…but if a short time-scale is used it will not have sufficient data to draw conclusions.
Also managers may appear good over one time period and bad over another.
Survivorship bias can negatively affect the peer group averages against which managers are compared (particularly in hedge funds which can disappear completely from the pool).
List six restrictions that might be included within an investment mandate (Subject SP5 revision).
Investment restrictions
(Subject SP5 revision)
Restrictions might include:
1. asset classes that are entirely prohibited
2. limitations on use of assets and asset classes, such as a prohibition on the speculative use of derivatives
3. maximum permissible holdings in individual assets or asset classes (to ensure diversification)
4. counterparty exposure limits for derivative instruments
5. prohibitions on ‘self-investment’ in sponsor’s own securities
6. ethical or social limitations.
List five other forms of regulatory requirements (in Subject SP5) that might influence the asset allocation.
Five regulatory requirements that might influence asset allocation (Subject SP5)
- localisation requirements that require matching of assets and liabilities by currency
- requirements to hold specific assets to back specific liabilities
- requirements to hold specific assets, such as government bonds
- prohibitions on the holding of specific assets
- admissibility requirements, that determine whether assets can be taken into account for solvency purposes
State three purposes of restrictions on investments (Subject SP5).
Three purposes of restrictions on investments
(Subject SP5)
- protect ultimate beneficiaries from gross incompetence or mis-management by fund managers
- encourage confidence in investment schemes and benefits they secure
- promote the accumulation of investible funds
Explain what is meant by:
* active money
* information ratio and state what each tells us.
Active money:
* Difference between portfolio weighting of share/sector and index/ benchmark weighting.
* Loosely, larger active money positions indicate greater divergence from the benchmark and hence more risk relative to benchmark.
* Doesn’t provide complete picture of ‘risk’ versus the benchmark, as some stocks more likely to perform very differently to benchmark than others (eg those with high betas).
Information ratio:
* Ratio of mean of relative return divided by standard deviation of relative return.
* Indicates how efficiently additional risk can be converted into additional return.
NB! Usually annualised
So adjustments need to be made to numerator and denominator if time periods not annual
Numerator: multiply the mean by the number of periods in the year
Denominator: multiply the calculated standard deviation by sqrt (t)
List five downside risk measures
(Subject SP5).
Five downside risk measures
(Subject SP5)
- value at risk (VaR)
- shortfall probability
- expected shortfall / tail VaR
- downside semi-variance
- downside semi-standard deviation
TVaR is a form of value at risk measure.
Define value at risk (VaR) and state the key assumption that is often made when calculating it
(Subject SP5).
Value at risk (VaR)
(Subject SP5)
VaR assesses:
– potential losses on portfolio
– over given future time period
– with given degree of confidence.
- Can be measured either in absolute terms or relative to benchmark.
- Often calculated assuming returns normally distributed.
