Chapter 16: The Portfolio Management Process Flashcards
what are the 3 broad categories of assets an investor’s money can be distributed amongst
- cash
- fixed income
- equity
what is the expected return and risk for cash
no expected return, no expected risk
what is the expected return and risk for fixed income
low expected return, low expected risk
what is the expected return and risk for equities
high expected return, high expected risk
what can asset allocation be
- fixed over the life of an investor (passive)
- change with market cycles (active)
what is the market life cycle
- expansion
- peak
- contraction
- trough
what happens at the expansion phase of the market life cycle
economic and profit growth
what happens at the peak phase of the market life cycle
maximum economic activity/profit in a cycle
what happens at the contraction phase of the market life cycle
economic and profit decline
what happens at the trough phase of the market life cycle
minimum economic activity/profit in a cycle
what is the goal of active asset allocation in terms of the market cycle
goal is to be more invested in equities between the trough and the peak, and less between the peak and trough
what is active asset allocation
- when you are actively looking for specific assets in a certain stage of the lifecycle to invest in
- constantly looking at the market
- high level asset allocation is called “strategic”
- generally fixed, but may change with changing characteristics of an investor (ex. from age)
what is tactical/dynamic/integrated asset allocation
- different names for the same thing
- shift the asset allocation based on short-term expectations for different asset classes
- may be based on macro, price, political, or other trends
what is passive asset allocation
when you don’t attempt to time the market, and hold one set of assets for a long period of time
what are the 2 types of passive asset allocation
- buy and hold limited number of individual stocks
- invest in a market index (like the S&P500)
what evidence is there for passive investing
investing in a market index passively performs better over time (in the long term)
what might a portfolio manager also do in addition to asset allocation
shift money between industries or sectors; called industry (sector) rotation
what are cyclical stocks and what do they do
- Cyclical stocks are like mining stocks that grow/decline with the economy
- they are more for active asset allocation
what are defensive stocks and what do they do
- Defensive stocks are like utilities, consumer staples
- they are stable regardless of economic conditions
what are “interest rate sensitive” stocks/bonds
- means they are directly impacted by changing interest rates
- like Banks and life insurers
- like Floating rate bonds/debentures
what are the different types of equity manager styles
- growth
- value
- sector rotation
what is the growth equity manager style
- Focus on companies with high revenue growth (like Meta)
- May pay high P/E (price to earnings ratio) for exposure to high growth
- those that are volatile and sensitive to earnings meeting or exceeding analysts expectations
- have low dividend yields
what is the value equity manager style
- Focus on mature companies with stable revenue
- Pay low P/E (price to earnings ratio)
- look for stocks with lower betas
- have higher dividend yields
what is the sector rotation equity manager style
- Macro driven industry selection
- focus on particular sectors
- e.g. oil vs. industrial vs. consumer discretionary
- results in higher volatility and greater risk since its less diversification
what are the different bond manager styles
- interest rate anticipators
- term to maturity
- credit quality
- spread traders
what is the interest rate anticipators bond manager style
- bet on interest rates rising or falling
- lengthen the term of the bond if they expect interest rates to fall
- shorten the terms when they expect rates to increase
- done to try to maximize capital gains
what is the term to maturity bond manager style
- Restricted to specific maturities (e.g. 3-5year bonds)
- limits the risk of the fund
what is the credit quality bond manager style
- Identify the best yields for a given credit quality; may bet on credit upgrades/downgrades
- they sell companies they think will go bankrupt, and will instead buy what they think is safer, like government bonds
what is the spread traders bond manager style
Long-short bond strategy betting on yield spreads between bonds to rise/fall (e.g. corporate vs. government spread)
how do you evaluate the performance of your investments
- by comparing the total return of your investments to an alternative benchmark
- total return formula is the same, but used for a portfolio instead of an individual security
- benchmark must be investible (an investor should be able to invest in the benchmark)
what could a benchmark be
- can blend different asset classes to reflect the investor’s asset allocation
- ex. could be 50% bond index, and 50% stock index
how do you calculate the total return of a benchmark
- the weighted average of any indexes you use
- you take the % the total benchmark will be made up of (ex. 30% of it is bonds), and multiply it by the total return of it
- then add it with any other index that will be combined to make the benchmark
what is the sharpe ratio
- commonly used metric for evaluation of a portfolio’s risk adjusted return
- measures unit of return per unit of risk
- return = total return
- risk = standard deviation
what is the sharpe ratio formula
(Rp - Rf) / SDp
- Rp = returns from the portfolio
- Rf = risk free rate (like a government bond yield)
- SDp = standard deviation
