Chapter 16: The Portfolio Management Process

Question 1

what are the 3 broad categories of assets an investor’s money can be distributed amongst

Answer 1

• cash
• fixed income
• equity

Question 2

what is the expected return and risk for cash

Answer 2

no expected return, no expected risk

Question 3

what is the expected return and risk for fixed income

Answer 3

low expected return, low expected risk

Question 4

what is the expected return and risk for equities

Answer 4

high expected return, high expected risk

Question 5

what can asset allocation be

Answer 5

• fixed over the life of an investor (passive)
• change with market cycles (active)

Question 6

what is the market life cycle

Answer 6

• expansion
• peak
• contraction
• trough

Question 7

what happens at the expansion phase of the market life cycle

Answer 7

economic and profit growth

Question 8

what happens at the peak phase of the market life cycle

Answer 8

maximum economic activity/profit in a cycle

Question 9

what happens at the contraction phase of the market life cycle

Answer 9

economic and profit decline

Question 10

what happens at the trough phase of the market life cycle

Answer 10

minimum economic activity/profit in a cycle

Question 11

what is the goal of active asset allocation in terms of the market cycle

Answer 11

goal is to be more invested in equities between the trough and the peak, and less between the peak and trough

Question 12

what is active asset allocation

Answer 12

• 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)

Question 13

what is tactical/dynamic/integrated asset allocation

Answer 13

• 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

Question 14

what is passive asset allocation

Answer 14

when you don’t attempt to time the market, and hold one set of assets for a long period of time

Question 15

what are the 2 types of passive asset allocation

Answer 15

• buy and hold limited number of individual stocks
• invest in a market index (like the S&P500)

Question 16

what evidence is there for passive investing

Answer 16

investing in a market index passively performs better over time (in the long term)

Question 17

what might a portfolio manager also do in addition to asset allocation

Answer 17

shift money between industries or sectors; called industry (sector) rotation

Question 18

what are cyclical stocks and what do they do

Answer 18

• Cyclical stocks are like mining stocks that grow/decline with the economy
• they are more for active asset allocation

Question 19

what are defensive stocks and what do they do

Answer 19

• Defensive stocks are like utilities, consumer staples
• they are stable regardless of economic conditions

Question 20

what are “interest rate sensitive” stocks/bonds

Answer 20

• means they are directly impacted by changing interest rates
• like Banks and life insurers
• like Floating rate bonds/debentures

Question 21

what are the different types of equity manager styles

Answer 21

• growth
• value
• sector rotation

Question 22

what is the growth equity manager style

Answer 22

• 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

Question 23

what is the value equity manager style

Answer 23

• 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

Question 24

what is the sector rotation equity manager style

Answer 24

• 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

Question 25

what are the different bond manager styles

Answer 25

• interest rate anticipators
• term to maturity
• credit quality
• spread traders

Question 26

what is the interest rate anticipators bond manager style

Answer 26

• 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

Question 27

what is the term to maturity bond manager style

Answer 27

• Restricted to specific maturities (e.g. 3-5year bonds)
• limits the risk of the fund

Question 28

what is the credit quality bond manager style

Answer 28

• 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

Question 29

what is the spread traders bond manager style

Answer 29

Long-short bond strategy betting on yield spreads between bonds to rise/fall (e.g. corporate vs. government spread)

Question 30

how do you evaluate the performance of your investments

Answer 30

• 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)

Question 31

what could a benchmark be

Answer 31

• can blend different asset classes to reflect the investor’s asset allocation
• ex. could be 50% bond index, and 50% stock index

Question 32

how do you calculate the total return of a benchmark

Answer 32

• 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

Question 33

what is the sharpe ratio

Answer 33

• 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

Question 34

what is the sharpe ratio formula

Answer 34

(Rp - Rf) / SDp

• Rp = returns from the portfolio
• Rf = risk free rate (like a government bond yield)
• SDp = standard deviation