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Investment Management Techniques > Chapter 3 - Asset Allocation & Investment Strategies > Flashcards

Chapter 3 - Asset Allocation & Investment Strategies Flashcards

1
Q

What are the 3 non-style based bottom up analysis approaches?

A

Pure fundamental
Pure quantitative
Pure technical

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2
Q

What are the 2 categories of top down approaches?

A

Macroeconomic approach
Style based approach

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3
Q

What is a sector rotator?

A

An investor who employs a top-down macroeconomic approach to investment analysis.

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4
Q

What is the style-based approach to top down investment analysis?

A

Selecting stocks from whichever style is expected to perform best given the analysis of large-scale factors and capital market factors (ex. Small cap value, large cap growth, etc.)

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5
Q

What are the two passive equity strategies?

A

Indexing
Buy and hold

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6
Q

What are the 2 style based bottom up approaches to equity analysis?

A

Value and growth
Market capitalization

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7
Q

What is machine learning and what are the 3 types of machine learning?

A

Machine learning is a subfield of AI that develops and uses algorithms that give machines the ability to automatically learn and improve with experience using data, without being explicitly programmed.
1. Supervised learning
2. Unsupervised learning
3. Reinforcement learning

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8
Q

How do supervised, unsupervised, and reinforcement machine learning differ from one another?

A

Supervised learning involves labelled datasets during training. The computer learns patterns from the dataset’s paired input and output (label) values.
Unsupervised learning using unlabelled datasets. The algorithm is given inputs but not provided output values (labels), the algorithm discovers structures in the data such as patterns our groupings.
Reinforcement learning involves the algorithm receiving positive or negative feedback based on decisions made within a training environment.

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9
Q

What is deep learning?

A

A subfield of machine learning using artificial neural networks (ANNs) algorithms that attempt to mimic the human brain. Interconnected nodes attempt to mimic neurons and are arranged in layers where information is passed from one to the next to process large and complex data sets.

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10
Q

What is natural language processing?

A

A subfield of AI that creates computer programs that understand human language by reading text or hearing speech and uses it for an intended purpose such as analyzing large amounts of text/speech.

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11
Q

What is “big data” and what are the characteristics of big data?

A

Large and more complex collections of information that traditional databases cannot capture, manage, and process.
Characterized by “V”s: volume, variety, velocity, veracity, value, variability, visualization.

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12
Q

What are the 7 ‘V’s of big data?

A

Volume - amount of data involved
Variety - formats of data (audio/video, HTML, tables of data)
Velocity - speed that data is created and received
Veracity - quality, accuracy
Value - benefit of the data, usefulness
Variability - received in different formats, different sources
Visualization - once processed, it must be put into a clear and understandable format

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13
Q

When in Canada was discretionary portfolio management outside of a physical location permitted?

A

2014
Since then, several online advisory businesses have launches. Non-discretionary online wealth management is also available.

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14
Q

What are the 4 trends that have given rise to robo-advisors?

A
  1. Shifting demographics
  2. Passive investing trend
  3. Technological changes (social networks, mobile devices, predictive analysis)
  4. Demand for transparency (fees, performance)
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15
Q

What is factor-based investing?

A

Investing based on specific characteristics (factors). Most commonly used equity factors are value, momentum, size, quality, low volatility.

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16
Q

What is the “momentum” equity factor? How does this investing strategy work?

A

Stocks of companies that have outperformed based on price appreciation in a recent time period would be expected to continue to outperform (based on momentum).

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17
Q

What are smart beta ETFs?

A

Also known as strategic beta ETFs or factor ETFs. These are long-only portfolios that may track a defined alternative index or be constructed using one or more factors instead of replicating a conventional market-cap-weighted index.

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18
Q

What are the disadvantages of smart beta ETFs?

A

Reduced diversification by focusing on specific factor-based strategies.
Factors are shown to be cyclical over time, so strategies can underperform during down periods.
Higher management fees.

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19
Q

What are the (5) equity factors commonly used in North American investment management products?

A
  1. Value (stocks with low PE low PB)
  2. Momentum (recent stock price appreciation)
  3. Size (capitalization)
  4. Quality (stocks with high ROE, stable earnings, low leverage)
  5. Low volatility (smaller standard deviation)
    Bonus (6) - dividend yield**
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20
Q

What indices do smart beta ETFs use and how does this work?

A

They require alternative indices. Index providers (such as S&P, MSCI, FTSE Russell) receive a licensing fee from an ETF in exchange for data on the index performance and the index’s portfolio holdings.

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21
Q

What is responsible investment?

A

The incorporation of environmental, social, and governance (ESG) factors into the selection and management of investments.

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22
Q

What are the 3 main financial risks associated with climate change?

A
  1. Physical risks - damage property values, disruptions to trade and supply change.
  2. Liability risks - impacts that could arise from parties seeking compensation due to loss or damage from the effects of climate change.
  3. Transition risks - generated by the process of adjustment towards a lower-carbon economy, such as policy and regulatory changes.
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23
Q

What is an example of a quantitative approach for investors/companies to manage their climate risk?

A

Carbon footprint measurement - sum of a proportional amount of each portfolio company’s emissions.

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24
Q

What is SOP when referring to executive compensation?

A

Say on Pay. Shareholder votes on executive compensation are mandated in the US, may eventually become mandated in Canada as well. Currently voluntary.

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25
Q

What is the impact of diversity in companies?

A

According to a report by the Centre for International Governance Innovation, there’s a 2.4% increase in revenue associated with a 1% increase in ethnic diversity.

A McKinsey analysis in 2019 found that companies in the top quartile for gender diversity on executive teams were 25% more likely to have above-average profitabiltiy than companies in the fourth quartile.

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26
Q

What are (4) prominent examples of ESG research firms?

A

MSCI
Sustainalytics
Refinitiv
ISS-ESG

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27
Q

What is the objective of ESG research?

A

Clearly identify a company’s strengths and weaknesses relative to its peers while highlighting any ESG-related events that could have a material impact on the company’s valuation.

28
Q

What are NGOs?

A

Non-government organizations.

29
Q

What is shareholder engagement as an RI strategy?

A

Communication with companies to influence their ESG performance by…
- Engaging in dialogue with management and boards of directors
- Filing or co-filing shareholder resolutions
- Voting proxies based on ESG criteria

30
Q

What is a shareholder resolution?

A

Also called a “shareholder proposal”, it is a formal request for action from an investor that is voted on at a company’s annual general meeting (AGM). The purpose is to focus management attention on the issue and have the company adopt policies or practices that will help reduce risk and increase shareholder value. This approach is often utilized when dialogue fails to yield desired results.

31
Q

What is divestment as a means of shareholder engagement?

A

Selling shares to show displeasure with a company on their lack of an action plan (if other forms of engagement do not produce results). Divestment also ensures that an investor’s portfolio is consistent with the views of stakeholders who feel strongly about particular issues.

32
Q

What are common shares and what is the purpose of issuing them?

A

Issued by a corporation, represent ownership interest in the corp. Commonly issued for these reasons:
- Raising capital
- Paying dividends without cash (stock dividends)
- Buying other companies without cash
- Meeting obligations of a convertible security (ex: issued each time a convertible bond holder decides to convert their bond into common shares)

33
Q

What are the 3 general categories of dividends?

A
  1. Regular dividends
  2. Extra dividends
  3. Stock dividends
34
Q

When do stocks begin to trade ex-dividend? What does this mean?

A

On the first business day before the record date, since it takes stock trades 2 business days to settle after the trade date (T+2). If a stock is trading ex-dividend, it means the buyer will not receive the declared dividend for shares traded on or after the date.

35
Q

What are ‘extra dividends’?

A

May be paid because of unusually favourable circumstances and may not be repeated, generally by companies with a lot of cash on hand and no opportunities to invest in ongoing or new business ventures.

36
Q

What are stock dividends and what is the purpose of them?

A

Stock dividends are paid to shareholders in the form of additional common shares instead of cash, preserving a company’s cash for internal use. This does dilute a company’s EPS.

37
Q

What is a company’s payout policy?

A

The choice to initiate/increase dividends, pay extra dividends, and/or to repurchase common stock.

38
Q

What is a company’s value derived directly from?

A

Its cash flow generating capability,’free cash flow (FCF)’. The amount a company can pay out to its equity investors is directly dependent on FCF, though it doesn’t matter if FCF payout is done through dividends or common share repurchases.

39
Q

What are the advantages/disadvantages of dividend paying stocks?

A

Dividends provide a stable income for common shareholders. However, the income tax rate for dividends is generally higher than that of capital gains, and the investor is not able to defer taxes (like with capital gains) as they must pay taxes on the dividends in the year they’re received.

40
Q

Why are share repurchase payout policies generally preferred by company management?

A

Share repurchases reduce the number of shares outstanding and increases the EPS. This is then supportive of management performance metrics that are based on per-share metrics (such as EPS). Another benefit is partially or totally offsetting the dilutive impact of common share option grants exercised over time.

41
Q

What does a share repurchase payout policy generally signal to the markets?

A

The market often views share repurchases as a signal that management feels the company’s share price is currently undervalued. Share repurchases benefit remaining shareholders, who often include members of management.

42
Q

What are preferred shares characterized by?

A

Their par value and dividend rate. If a company winds up operations, preferred shareholders are entitled to receive only up to the par value of their shares.

43
Q

What does it mean if preferred share dividends are cumulative?

A

Dividends that are not paid out accrue and must be paid out before dividends to common shareholders are paid.

44
Q

Do preferred shareholders have voting privileges?

A

No. Only if a stated number of dividend payments are omitted.

45
Q

Why are preferred shares interest rate sensitive and similar to debt securities?

A

Due to their fixed claim on company assets and their fixed dividends. They fall in value when interest rates rise and rise in value when interest rates fall.

46
Q

What are the 6 Canadian stock exchanges? Which are owned by TMX Group Ltd.?

A
  1. Toronto Stock Exchange (TSX)
  2. TSX Venture Exchange (including NEX)
  3. Canadian Securities Exchange (CSE)
  4. TSX Alpha Exchange
  5. Cboe Canada (formerly NEO Exchange)
  6. Nasdaq Canada
    TMX Group owns TSX, TSX Venture, TSX Alpha.
47
Q

Which type of securities are generally listed on the TSX?

A

Securities of senior issuers. Primarily common shared, with some preferred shares, REITs, and limited debentures.

48
Q

Which types of securities are listed on the TSX Venture Exchange?

A

Securities of junior issuers, which are mainly emerging firms.

49
Q

What happens to companies that fall below the TSX Venture Exchange’s listing standards?

A

Those companies can trade on the NEX, which is a separate board of the TSX Venture Exchange. Companies formerly listed on the TSX/TSX Venture are eligible for the NEX. It allows companies to maintain a TMX Group listing while improving their business prospects.

50
Q

What is the Canadian Securities Exchange?

A

The OSC recognizes the company that operates the CSE, CNSX Markets Inc., as a stock exchange. The CSE positions itself as a low-cost alternative to traditional stock exchanges, with common shares, some government bonds and structured products listed.

51
Q

What is the New York Stock Exchange (NYSE)?

A

Arguably the most recognized stock exchange in the world, with over 2300 mid- and large-cap companies listed on the NYSE. Canadian companies often interlist on both the NYSE and TSX.

52
Q

What are American Depositary Shares (ADSs)?

A

An ADS is a security issued by a US depositary (usually a trust company) representing ownership interest in a foreign company’s securities. Companies issue ADSs to increase the marketability of their shares to investors trading on US exchanges. The term American Depositary Receipt (ADR) is often used interchangeably, though this is the certificate that represents ownership of an underlying company’s shares.

53
Q

What does the relationship between an American Depositary Share (ADS) and the price of an issuer’s securities on its home exchange depend on?

A

Depends on the exchange rate and how many of the issuer’s underlying securities are represented by each ADS.

54
Q

Why might an investor purchase an ADS on the NYSE as opposed to the actual underlying security on the home exchange?

A

Often cheaper in terms of transaction costs to purchase the ADS on the NYSE.

55
Q

Which types of stocks are listed on the NASDAQ?

A

Over 3,100 companies are listed, ranging from start-ups to large, well established companies.

56
Q

What was the traditional model of trading? What is the new trend in trade execution?

A

The traditional trading model involved market makers, where large orders were difficult to hide, resulting in market impact. The trend is to move towards a more anonymous electronic trade execution system.

57
Q

What is an alternative trading system (ATS)?

A

Off-exchange private electronic network that discreetly and directly matches buyers and sellers using a computer program. There are no intermediaries and large orders can be executed with little or no market impact.

58
Q

What have traditional exchanges been losing business to in recent years and how have they countered this?

A

Losing business to alternative trading systems (ATS) where there are no intermediaries and large orders are executed with little or no market impact. To counter this, traditional exchanges like NYSE and TSX have spent millions of dollars to upgrade technology to compete.

59
Q

How do alternative trading systems (ATS) in Canada compare to those in the US?

A

Development of an ATS network in Canada has been far slower than in the US, with a regulatory framework for the creation of an ATS market only existing since 2001, compared to Instinet having operated in the US since 1969.

60
Q

Who regulates Alternative Trading Systems (ATS) in Canada?

A

CIRO.

61
Q

What is the role of investment strategists? (Also called market strategists, portfolio strategists, etc.)

A

Analyze and comment on a wide variety of investment themes, including asset allocation, market valuation and forecasts, sector/industry analysis, and individual stock selection. Reports and articles often combine original research with work of economists and analysts. Most strategists maintain a recommended list of best stock picks.

62
Q

What is the role of equity analysts? (Also called research analysts or company analysts)

A

Equity analysts are employed by most Canadian investment dealers. They use fundamental analysis to estimate the return and risk of an investment in the common shares of companies in their coverage universe.

63
Q

What is a coverage universe?

A

A specific industry or sector (normally) that a research analyst covers. (Example: a gold analyst covers only companies involved in the exploration for and mining of gold.)

64
Q

What is one reason that is cited for why small-cap stocks outperform large-cap stocks?

A

Tendency of research analysts to focus on larger companies and ignore smaller ones (missed opportunities?)

65
Q

What is the purpose of industry analsysis for equity analysts and investment strategists?

A

For equity analysts, industry analysis is done to determine which companies in that industry are positioned to perform better than others. For investment strategists, industry analysis is completed to to compare industries to determine which could outperform.

66
Q

What is the purpose of an equity analyst determining the intrinsic value of a stock?

A

If shares are deemed to be mispriced from the stock’s forecasted intrinsic value, the analyst usually assumes the stock will eventually trade at its intrinsic value. They will establish a target price for the stock over some future ivnestment horizon that establishes the maximum potential return from owning the stock.

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