Chapter 21: Portfolio management (1) Flashcards
List nine investment management styles
Active Passive value growth momentum contrarian rotational top-down bottom up
Describe the general characteristics of growth stocks, and list 5 factors that you might use to identify them
Growth stocks that are expected to experience rapid growth of earnings, dividend and hence price
Five factors use to identify growth stocks
Return on equity earnings growth earnings revisions forecast earning growth sales growth
Describe the general characteristics of value of stocks, and list five factors that you might use to identify them
Value stocks are stocks that seems to represent good value in terms of certain key accounting ratios
Five factors use to identify value stocks
Cashflow yield Book to yield earnings yield dividend yield sales to price
Distinguish between active and passive investment management
Active investment management
Seeks to actively identify mispriced securities, which can then be traded to generate large returns
stock selection, sector selection, switching, market timing
Requires inefficient market
Passive investment management
Involves selecting securities that beset meet investor’s objectives and/or make up investor’s benchmark portfolio
securities then held passively and changed only in reaction to change in objectives and/or benchmark portfolio
eg index tracking, liability matching/hedging
Appropriate if market efficient
Explain briefly what is meant by each of the following investment management styles
Momentum
contrarian
Rotional
Momentum
Momentum investors purchases(sell) stocks that have recently risk (fallen) significantly in price on belief that they will continue to rise (fall) owing to an upward (downward) shift in their demand curves, thereby taking advantage of momentum effects
Contrarian
Investors do opposite to most other investors in belief that investors, and hence share prices, tend to overreact to news
Rotational
Rotational investors move between countries, sectors, industries or value and growth stocks depending on which style is believed to be attractive at any particular point in time, ie growth when market rising, value when market falling
Outline the top - down and bottom up approaches to portfolio construction and state their relative merits
Top down approach
First consider asset allocation between different asset classes
next considers, how to distribute available fund between different sectors (eg different industries for equities) within each asset class
Finally selects individual assets within each sector better control of risk of portfolio, as it ensures diversified portfolio and matching of liabilities focuses more on asset class choice, which has greatest overall effect on investment performance
Bottom up approach
Selects best value individual securities, irrespective of geographical or sectoral spread
Focuses on choice of individual securities, whose performance actually dictates that of portfolio as whole
Define the following types of analysis
Fundamental analysis
quantitative analysis
technical analysis
Fundamental analysis
Analysis of company’s share value and potential for future profits and dividends based accounting and economic information
Quantitative analysis
Modern mathematical techniques used to aid stocks and sector selection, ie asset pricing models in Chapter 18
Technical analysis
Analysis of historical market date on prices, yields and/or trading volumes to predict future market movements
List the three ways of replicating an index
Full replication - holding all securities in index in proportion to index weighting
Sampling or partial replication - holding representative sample of securities in index, which behaves in same way as index
Synthetically replicating index using derivatives and cash
Outline four potential advantages and five potential disadvantages of index tracking compared to active portfolio management
Four potential advantages of index tracking
+Risk of under performance index (and indirectly competitors) reduced
+lower dealing and research costs
+appropriate if market believed to be efficient
+tracking well diversified index ensure fund is well diversified, reducing specific risk and volatility of returns
Four potential disadvantages of index tracking
+Chance of over - performance index (and indirectly competitors) reduced
+Full replication involves forced buying/selling when index constituents changed and fragmented portfolio
+Resulting strategy may pay insufficient regard to investor’s objectives
+May prove difficult to find appropriate index to track
+May prove difficult to accurately track chosen index
State
2 conditions required in order for active investment management to be appropriate
One potential advantage and two difficulties with active management
Appropriate if
+Market inefficient
+possible to identify skilled investment managers who can exploit market inefficiencies
Advantage
+Offers possibility of higher returns
Difficulties
+Selecting out-performing investment managers
+timing changes to line up of active managers
Outline the two types of mandates under which active investment managers typically operate
+Multi - asset or balanced mandates - manage funds invested across a variety of different asset categories and will take decisions on:
Weightings across asset categories
And stocks within each asset category
Specialist mandates - specialise in particular asset category and employed to manage funds invested in that asset category only
Describe the core satellite approach to portfolio management
Majority of fund (‘core’ portfolio) managed on passive , low cost basis
Specialist satellite, active managers employed to provide increased performance (in excess of fees paid) in respect of balance of fund
Number of competing managers may be employed in respect of specialist asset classes
Satellite managers may include hedge fund and private equity specialists
List circumstances in which an individual bond will outperform its peers and outline why the return on a bond will pronounced negative skew
A bond could outperform its peers
If the issuer’s (relative) perceived creditworthiness improves
If the issue’s term, liquidity or other trading aspects improve
If there is a supply/demand imbalance
bond returns have a negative skew because
a bond’s out performance is bound (by highest rating category, and realistic interest rate changes)
A complete loss of value could occur
Describe
Anomaly switching
policy switching
Anomaly switching
involves moving between stocks with similar volatilities
take advantages of temporary anomalies in price
relatively low risk strategy
profits likely to be small
Policy switching
Involves taking view on future changes in shape and/or level of yield curve and moving into bonds with different volatilities
eg if yields expected to fall, switch into longer dated, more volatile stocks
Potentially high risk, high return approach
need to consider matching
Give 3 techniques for identifying anomaly switches
Compared current yield idfference between two similar bonds to recent avaerage value to determine if one of bonds seems cheap or dear relative to other
Compare price ratios in similar way to yield differences, allowing for any differences in coupon level
Use price and yield models. If actual price of yield differs from model prediction, then may be mis-pricing
