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CISI - Portfolio Construction Theory in Wealth Management > Chapter 7 > Flashcards

Chapter 7 Flashcards

1
Q

What are the three main assumptions in EMH?

A
  • a large number of profit-maximising participants
  • new information comes in randomly
  • participants no cognitive bias and price securities simply on new information
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2
Q

Why do efficient asset markets matter?

A

you can’t tell if a security is undervalued or overvalued without it

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3
Q

What is weak form efficient

A

current asset prices reflect all historical market information

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4
Q

What does the weak form EMH test?

A

whether publicly available information contained in historical prices is fully reflected in current prices

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5
Q

What is semi-strong form efficiency?

A

current prices reflect the same information in weak form

also, all public information

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6
Q

What does the semi-strong form efficiency test?

A

whether public information is fully reflected in current prices

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7
Q

What is strong form efficiency

A

current prices reflect all relevant information, including historical prices

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8
Q

What does the strong form efficiency test? (2)

A

whether all information (public and private) is fully compounded in market prices

and whether any type of investor can make excess profits

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9
Q

What kind of analysis may generate abnormal returns under weak EMH?

A

fundamental analysis

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10
Q

Why does fundamental analysis work in weak form EMH?

A

current prices may not reflect information about a public company

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11
Q

What kind of tests are used for weak form EMH?

A

random walk

zero correlation between past return and current return

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12
Q

Who have a knowledge advantage in semi-strong form EMH?

A

directors and other insiders that hold private information

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13
Q

What kind of studies are used to test semi-strong form efficiency? (3)

A

event studies

sample of firms that have an important announcement or event

then calculate abnormal return

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14
Q

What is the debate regarding strong form efficiency? (2)

A

markets efficient no room for active management

markets are inefficient and active management can generate alpha

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15
Q

Is there cyclicality between active and passive management? (2)

A

active strategies tend to outperform during market corrections

able to capture more upside during a recovery

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16
Q

Following a review of the EMH, what are the two main categories of tests of the EMH?

A
  • price studies
  • manager studies
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17
Q

What are the prices studies of EMH?

A

searching for trade rules that generate positive risk-adjusted returns when back-tested on historical data

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18
Q

What are the manager studies of EMH?

A

test the ability of active managers to generate risk-adjusted outperformance

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19
Q

What are the three anomalies in EMH?

A
  • small firms outperform large firms
  • evidence on mean reversion
  • higher daily returns before a public holiday
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20
Q

What is the key belief in EMH?

A

markets are quick to process new information, so investors are
unable to gain an advantage over other investors.

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21
Q

Which is more market efficient large developed markets or small less developed markets? (3)

A

lage markets

more efficient

more analysts and news more available

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22
Q

What are the challengers to market efficiency? (3)

A

markets driven by human (irrational)

markets are structurally inefficient

many investors have consistently beaten the market i.e. warren buffett

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23
Q

What are the two ways of constructing a portfolio actively? ^ v

A
  • top down
  • bottom up
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24
Q

What is top down portfolio construction?

A

assessing macroeconomic factors that lead to a particular asset allocation

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25
What is bottom-up portfolio construction?
focuses solely on the unique attractions of individual stocks
26
What is fundamental analysis?
examination of macro and micro economic metrics estimating intrinsic value of companies
27
What is the aim of fundamental analysis? (3)
forecasting future profits determining fair value and potential for mispricing
28
What is technical analysis?
look at the pattern of price and volumes of market behaviour with a view to anticipating the overall direction of a market or individual securities
29
What is the intellectual justification for technical analysis? (2)
it's based on behaviour of crowds markets filled with people who behave the same way when faced with similar market conditions
30
What is quantitative analysis? (2)
using mathematical models to price products then use that price to gauge whether share is expensive or cheap
31
How does quantitative analysis aim to exploit market inefficiency?
use computer technology to swiftly execute trades
32
What is the return like with quantitative analysis?
small needs leverage to boost returns
33
What is the concept behind factor investing?
security returns are explained by multiple 'factors' that could be used to predict returns
34
Give examples of factors used in factor investing (6)
- company size - growth - valuation - profitability - leverage - momentum
35
What is value investing? (3)
- companies in distress - companies set for recovery - hope price return to reflect their intrinsic value
36
How do you do value investing? (2)
- screen for shares that are super cheap - compared to chosen yardsticks
37
What are the three key ratios in value investing?
- share price to assets - earnings - dividends
38
What is growth investing? (3)
- focus on companies with rising share price - hope momentum keeps going - and other investors join the bandwagon
39
What are true growth stocks? (2)
- able to differentiate their product or service - have a competitive advantage
40
What is a growth stock?
one that has yet to gain market prominence but has potential to do so
41
What is the key to growth investing?
rigorously forecast future earnings growth and avoid companies susceptible to issuing profits warnings
42
What is Growth at a reasonable price (GARP) investing?
any P/E is reasonable if it is equal or less than the company's annual rate of earnings growth
43
Give an example of GARP
accept a P/E multiple of 15 if company's earnings are growing at annual rate of at least 15%
44
What does GARP do for managers?
sets bounds on how much higher a P/E is justifiable
45
What other protective valuation measures can be used apart from GARP? (2)
- dividend cover - borrowings and liquidity
46
What is commingling? (2)
portfolio made of multiple unit trusts, OEICs and/or investment trusts rather than forming an index fund
47
Who is suitable for commingling? (3)
- investors with relatively small portfolios - accept compromise between transaction costs of complete indexation - and tracking error of stratified sampling
48
What does tracking error measure?
how closely returns have tracked the targeted benchmark index
49
What is a good annualised TE when tracking a benchmark?
less than 1%
50
What is duration swtiching?
changing duration of portfolio depending on expected interest rates
51
For duration switching, what happens to duration of portfolio in bear market?
shorten duration
52
For duration switching, what happens to duration of portfolio in bull market?
increase duration
53
What is riding the yield curve?
buying long-term bond but selling it before maturity to profit from a declining yield over the bond's life
54
What are the two main classes of bond switches?
- anomaly switches - policy switches
55
What is an anomaly switch?
switch between two bonds with very similar characteristics, but whose prices or yields are out of line with each other
56
What is a pure yield switch?
sale of a bond that has a given GRY and the purchase of a similar bond with a g greater GRY
57
What is a policy switch?
switch between two dissimilar bonds
58
What does a policy switch aim to take advantage of? (3)
- change in interest rates - term structure of interest rates, - change in credit ratings
59
For a policy switch, how do they take advantage of change in interest rates?
low duration interest rates go up high duration if interest rates expected to go down
60
For policy switching, how to take advantage of changes in the structure of the yield curve?
- yield curve normally smooth line - bonds on a hump, price will go up - bonds on a dip, price will go down
61
For policy switching, how to take advantage of changes in bond quality ratings?
expected rating to go down, price down expected rating to go up, price up
62
What is intermarket spread switching?
- different sections of simlar market - different terms - to obtain a more positive yield spread
63
Example of intermarket spread switching
- spread between government and corporate bonds to narrow - swap government bonds for corporate bond
64
Bonds What is a laddered portfolio?
buying securities with various maturities
65
What is benefit of laddered portfolio?
reduce portfolio's sensitivity to interest rate risk
66
What is a bullet or focused portfolio?
constructed from bonds with maturities or durations close to that of liabilities
67
What is a barbell portfolio?
only short dated and long dated bonds
68
What are the roles of the bonds in a barbell portfolio?
- long-dated for attractive yield - short-dated to invest money somewhere else during a downturn
69
What is the advantage of a barbell strategy?
wider range of portfolios with different duration can be constructed compared with a focused strategy
70
What is the disadvantage of a barbell strategy?
further immunisation risks than the focused strategy
71
What is cash flow matching?
purchase bonds whose redemption proceeds will meet a liabilityof the fund as they fall due
72
What are the benefits of active management? (6)
- tailor an active strategy to meet a specific investment goals - potential for better reutns - flexibility to choose assets they believe will provide a strong return - flexibility can reduce risk - teams of analysts support active managers in finding attractive investment opportunities - can be challenging which some might enjoy
73
What are the three limitations of active management? (Commodities)
- commodities trades high levered (magnifies gains and losses - commodities prices extremely volatile compared to other major asset classes - volatility is influenced by macroeconomic factors
74
What are the benefits of passive management? (7)
- reduced marketing, distribution and accoutning costs - liquid - transparent - minimal market trading - long term investors can benefit from higher returns - wide variety of indices are available - ETFs more tax efficient than mutual funds (better for tax-sensitive investors)
75
What are the limitations of passive management? (5)
- when adjusting when constituents change, may end up buying at elevated, or selling at depressed prices - costs affect performance relative to the index - unlikely to employ risk management, so can never outperform the index - can be overly concentrated, vulnerable to major political and regulatory events - still exposed to market risk, will follow the index down in bear markets -
76
What are the limitations of passive management?
- when adjusting when constituents change, may end up buying at elevated, or selling at depressed prices - costs affect performance relative to the index - unlikely to employ risk management, so can never outperform the index - can be overly concentrated, vulnerable to major political and regulatory events - still exposed to market risk, will follow the index down in bear markets - buy and sell decisions based on index constituents, not research - with full replication, securities are considered to be sub-optimal are still included
77
what is a core and satellite portfolio?
hold passively managed funds (about 70%+) include specialist actively mange funds for outperformance
78
What is smart beta? (3)
create custom benchmark consisting of stocks that exhibit certain behaviours low val, value, momentum passive strategy as the fund tracks that benchmark

CISI - Portfolio Construction Theory in Wealth Management (15 decks)

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