Chapter 18 Flashcards
Passive Management
Holding a well-diversified portfolio without attempting to search out security mispricing
Cash
Shorthand for virtually risk-free money market securities.
Active Management
Attempts to achieve returns higher than commensurate with risk by forecasting broad markets and/or by identifying mispriced securities.
Comparison Universe
The set of portfolio managers with similar investment styles that is used to assess relative performance.
Alpha Capture
Construction of a positive-alpha portfolio with all systematic risk hedged away.
Alpha Transfer or Alpha Transport
Establishing alpha while using index products both to hedge market exposure and to establish exposure to desired sectors.
What are the 3 Steps to Portfolio Evaluation?
- Portfolio return
- Selection of a benchmark
- Selection of comparison method
Types of Portfolio Return (3)
- Arithmetic average rate of return
- Time weighted rate of return
- Geometric rate of return
- Managers’ performance (buy and hold)
- Value weighted rate of return
- Internal rate of return
- Investors’ actual performance
Step 2: Selection of Benchmark. Examples
- S&P 500; DJIA – General market index
- NYSE composite; Wilshire 5000- Market
- Russell 2000 –Small cap
- Russell 2000 Growth –Small cap growth
- Russell 2000 Value – Small cap value
- Barclays Capital Aggregate Bond Index
- MSCI EAFE – International developed
What are the different Comparison Methods? (4)
- Sharpe ratio
- Treynor ratio
- Information ratio
- Jensen’s alpha; multifactor alpha
Sharpe Ratio
Reward-to-volatility ratio; ratio of portfolio excess return to standard deviation.
- Used when choosing among competing portfolios that will not be mixed.
- Used for entire portfolio or wealth
Treynor Ratio
Ratio of portfolio excess return to beta.
- Used to evaluate portfolio that is part of larger portfolio with different managers.
- Diversified Portfolios
Information Ratio
Ratio of alpha to standard deviation of diversifiable risk.
- Actively Managed Investments
Jensen Measure
Alpha of an investment
- Diversified Portfolios
Futures Contract
- they specify the purchase or sale of some underlying security at some future date
- carries the obligation to go through with the agreed-upon transaction
Bull Market
group of securities in which prices are rising or are expected to rise
Bear Market
prices are falling and widespread pessimism causes the negative sentiment to be self-sustaining.
Nine-Step Investment Process
- Develop an understanding of the client’s goals
- Identify a target rate of return
- Agree on the time horizon
- Determine the client’s tolerance and capacity for risk
- Define the asset classes
- Determine an appropriate asset allocation
- Create the IPS
- Select the Investments themselves
- Monitor and adjust as needed
Strategic Asset Allocation
core: low fee, low tax cost; capture beta
Tactical Asset Allocation
- satellite: active management, sector; capture alpha
- behavioral consideration
