Chapter 17: Investment Mangement

Question 1

Active vs Passive investment

Answer 1

Active Investment:
Investment manager has little restrictions on the investment choice with a broad benchmark of asset classes. The manager is allowed to buy and sell whenever he thinks there is an opportunity. Mispricings can identified and leveraged

Passive investment:
Involves buying and holding asset classes which closely reflecting those underlying an index or specified benchmark. The investment manager has little freedom of choice.

Question 2

Considerations before implementing Tactical asset allocation CEPEL T

Answer 2

Constraints on the changes that can be made to the portfolio

Expected extra return relative to any additional risk

Problems involved with switching a large portfolio

Expenses of making the switch

Level of assets available (Proportion of assets moved)

Tax implications (realisation of any capital gains will result in tax) and timing of the deviation

Question 3

Risk budgeting

Answer 3

Process of establishing how much risk should be taken and where it is most efficient to take the risk.
Two parts:

• Deciding how to allocated the maximum permitted overall risk between active and strategic risk
• Allocating the active risk budget across the component portfolios

The goal of risk budgeting is to establish a risk culture within the company

Question 4

Risk Investment managers face

SAS

Answer 4

Strategic risk- Risk that the strategic benchmark does not meet the liabilities
Active risk - The risk individual managers take when they chase higher returns
Structural risk - Aggregate of Investment managers benchmarks not meeting overall benchmark

Question 5

Money weighted rate of return

Answer 5

The rate where the present value of cash inflows = present value of cash outflows

Generated cashflows ignored, only new money considered

Puts higher weighting when the fund was large
Unfair towards investment managers performance since deposits/withdrawals is out of his control

Question 6

Time weighted rate of return

Answer 6

The compounded growth rate of 1 over the period being measured

Does not take into account inflows or outlfows of money into the fund. Does not take into account managers with skill at handling larger portfolios

Question 7

Pros and Cons of Active investment JEL JED

Answer 7

Judge future performance of assets
Expected returns are higher
Limited Restrictions on investment

Judgment error risk exists
Efficient market - inability to outperform
Dealing costs

Question 8

Merits of Passive investment EIS PIT

Answer 8

Expenses are less
Index tracking is possible
Smaller expected return and volatility

Poor index performance
Investment freedom is restricted
Tracking errors

Question 9

The technique of risk budgeting BAPEAR

Answer 9

Strategic risk benchmark set
Active and strategic risk allocation
Portfolio risk allocation of active risk relative to strategic risk
Efficiency of active management measured
Appetite of risk at given level determined
Risk correlation considered - total risk managed