Chapter 8 Flashcards
What are the two principal approaches to asset allocation?
1) theoretical - backward looking uses mathematical analysis based on risk reward relationship. The efficient frontier.
2) pragmatic - forward looking. Uses average rates of return and historical data on long time periods.
What is modern portfolio theory?
Works on the principle that customers would not take risks that they didn’t need to whilst attempting to meet their investment objectives.
What is an optimised portfolio expected to deliver?
Highest return for a given level of risk.
What assets are you looking to combine in relation to correlation?
Negatively correlated assets. Combine assets that have the lowest correlation. This would provide the best diversification.
What is stochastic modelling?
Relies on assumptions. It sets up a set of standard assumptions including rules such as
- if inflation goes to x equities will increase by a.
It gives a multitude of what If combinations which are the applied to a particular asset allocation. The results are plotted graphically.
What 3 things is a risk profile a combination of?
1) risk tolerance
2) capacity for loss
3) return target - if their target is achievable or realistic
What are the 3 main ways to build a portfolio?
1) historic - use of past performance to influence asset allocation within a portfolio
2) adjusted historic - using past performance to adjust future expectations in terms of return and volatility
3) stochastic- use of a modelling tool
What are the 3 pieces of essential data to sort through when looking for a potential investment?
1) return required
2) volatility accepted
3) correlation of assets
What is top down portfolio construction?
1- determine asset allocation
2- allocate geographical spread
3- choose sector weightings
4- choose stocks taking into account any preferences
What is bottom up portfolio construction?
1- stocks are selected
2- asset allocation is created
What are the two main types of protection?
Hard protection - investment is linked to a stock market. If the index falls then the capital is returned but if it rises then the gains up to a cap are paid to the investor
Soft protection - capital is at risk if a threshold condition is breached. Income of 5% will be paid annually and capital returned provided the index does not fall by more than 20%.
What are the 6 main filters applied to fund selection?
1) fund objective
2) costs and charges
3) reputation and strength of the provider
4) individual fund manager skill and reputation
5) fine type and structure
6) fund performance
What are the 8 charges applied?
1) annual management charge
2) ongoing charges figure
3) performance fees
4) total cost of ownership
5) initial charge
6) bid offer spread
7) stamp duty
8) turnover
What does the ongoing charges figure include?
All costs except initial charges, exit charges, performance fees and dealing costs.
What is the annual management charge for passive and advice funds?
Passive funds vary from 0.2% to 0.75%
Active funds vary from 0.75% to 1.75%
