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CFA L3 > Equity > Flashcards

Equity Flashcards

1
Q

What is optimisation

A

It uses mean variance analysis to minimize tracking error. It typically maximizes a desirable result or minimises an undesirable characteristics

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2
Q

Process of fundamental active investment process

A

1) Define the investment universe in accordance with fund mandate
2) prescreen the investment universe to obtain manageable set of securities for detailed analysis
3) analyse the industry, competitive position and financial reports to the companies
4) forecast performance, most commonly based on cash flows or earnings
5) convert forecast to valuations
6) construct portfolio with desired risk profile
7) rebalance portfolio as needed

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3
Q

What is the process of quantitative active investment strategy

A

1) Define the market opportunity
2) Acquire and process data
3) back test the strategy
4) evaluate the strategy
5) construct the portfolio

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4
Q

What is active share

A

Active Share is a metric that measures how different a portfolio is from its benchmark in terms of holdings. It tells you what percentage of a portfolio’s investments are not shared with its benchmark. This helps in assessing how actively managed a portfolio is.

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5
Q

What is active risk?

A

Active risk is the standard deviation of active returns

Active risk (also known as tracking error) measures the variability or deviation of a portfolio’s returns from its benchmark due to the portfolio manager’s active investment decisions. It tells us how much risk is being taken by deviating from the benchmark.

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6
Q

What is thematic screening

A

Thematic investing focuses on investing in companies within a specific sector or following a specific theme such as energy efficiency or climate change

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7
Q

Rationale for choosing active management over passive

A

Confidence the manager has the expert knowledge and skill
Client preferences
Mandate from clients to invest in certain companies

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8
Q

Risks of active management

A
  • reputation risk
  • key person risk
  • higher portfolio turnover
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9
Q

Market oriented approach

A

Segments companies by markets served, how products are used by consumers and how cash flows are generated

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10
Q

Production oriented approach

A

Segments companies by products manufactured and inputs required during production process

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11
Q

Define tracking error

A

Tracking error refers to the standard deviation of the differences between index portfolio returns and published index futures

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12
Q

Causes of tracking error

A
  • management fees
  • commissions on trades
  • sampling
  • intra day trading
  • cash drag
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13
Q

Morningstar style box

A

In a style box - 2 factors - value and size - are each split into 3 groups

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14
Q

value based approaches

A
  • Relative value
  • Contrarian investing
  • High quality investing
  • Income investing
  • Deep value investing
  • Restructuring and distressed debt investing
  • special situations
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15
Q

Growth based approaches

A
  • Consistent long term growth
  • Shorter term earnings momentum
  • GARP (often uses peg ratio)
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16
Q

merits of long only investing

A
  • long term risk premiums
  • capacity and scalability
  • limited legal liability laws
  • regulations
  • transactional complexity
  • costs
  • personal ideology
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17
Q

benefit of long short strategy

A
  • greater ability to express negative ideas
  • ability to use leverage
  • ability to remove market risk
  • greater ability to control exposure to risk factors
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18
Q

drawback of long/short strategy

A
  • loss if market price increases
  • some strategies require significant leverage
  • cost of borrowing can become too high
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19
Q

Slippage

A

the differecne between the execution price and the midpoint of the quoted market bid/ask spread at the time the trade was entered

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20
Q

Heuristic risk constraints

A

Based on experience or general ideas of good practice

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21
Q

Formal risk constraints

A

statistical in nature.

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22
Q

Rebalancing of portfolio

A

Rebalancing involves adjusting the portfolio’s constituent weights after price changes, mergers, or other corporate events have caused those weights to deviate from the benchmark index.

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23
Q

Reconstitution of the portfolio

A

Reconstitution involves deleting names that are no longer in the index and adding names that have been approved as new index members

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24
Q

Disadvantage of a factor based strategy

A

high concentration on risk exposures

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25
Q

Factor based strategies are risk or return oriented?

A

Return oriented strategies

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26
Q

what is fundamental management

A
  • Based on manager’s discretion and judgement
  • focus on selectively smaller number of firms
  • can be top down or bottom up
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27
Q

Morningstar calculation

A

Morningstar calculates a score for value and growth on a scale of 0 to 100 using five proxy measures for each. The value score is subtracted from the growth score. A strongly positive net score leads to a growth classification, and a strongly negative score leads to a value classification. A score relatively close to zero indicates a core classification.

28
Q

Lipper methodology

A

The Lipper methodology does have a core classification. It sums the Z-score of six portfolio characteristics over several years to determine an overall Z-score that determines either a value, core, or growth classification.

29
Q

Deep value investing

A

Deep value investing focuses on undervalued companies, which are often in financial distress, that are available at extremely low valuations relative to their assets. The rationale is that market interest in such securities may be limited, which increases the chance of informational inefficiencies.

30
Q

Contrairian investing

A

Contrarians expect the stocks to rebound once the company’s earnings rebound. Contrarian investors often point to behavioral finance research that suggests that investors tend to overweight recent trends and follow the crowd in making investment decisions. Therefore, contrarian investors purchase and sell shares against prevailing market sentiment.

31
Q

Deep value investing

A

deep-value investing approach focuses on undervalued companies that are available at extremely low valuation relative to their assets. Such companies are often those in financial distress, which is not reflective of financial strength or demonstrated profitability.

32
Q

High quality value investing

A

High-quality value investors focus on companies’ intrinsic values that are supported by attractive valuation metrics, with an emphasis on financial strength and demonstrated profitability. In their view, investors sometimes behave irrationally, making stocks trade at prices very different from intrinsic value based on company fundamentals.

33
Q

Multifactor products

A

high active share - low active risk

34
Q

Social investing

A

Refers to allocating capital to assets that address social challenges in the poorest of communities.

35
Q

GARP

A

Definition:
A hybrid approach combining growth and value investing principles.

Characteristics:
Targets companies with above-average growth that are reasonably priced.

Key Metric: PEG (Price/Earnings to Growth) ratio.

36
Q

Activist shareholding insights

A

Stake Size: Typically less than 10%; a full takeover is rarely pursued.

Investment Horizon: Shorter than buy-and-hold strategies but campaigns can last several years.

Diverse Participants: Includes hedge funds, pension funds, private investors, and others with varying strategies and time horizons.

37
Q

Application of style analysis

A

Identifies manager strategies.

Assesses consistency with stated investment objectives.

Supports diversification and risk management.

38
Q

Holding based style

A

Examines the actual portfolio holdings and their individual contributions to the portfolio’s investment style.

Holdings-based models are less effective for portfolios with significant derivatives, requiring caution in interpreting results.

39
Q

returns based style analysis

A

Uses historical fund returns compared to style index returns.
Ideal when portfolio holdings are unavailable.

40
Q

FTSE russell methodology

A

Employ a multifactor approach where a stock can exhibit characteristics of multiple styles.
A stock might be 60% value and 40% growth, based on predefined weights of factors like price-to-earnings or dividend yield.
Captures nuances of stocks with mixed attributes, enabling more flexible and realistic classification.

41
Q

strenghts of HSBA

A

Accuracy: More precise as it evaluates actual portfolio holdings.
Transparency: Shows how each stock contributes to the portfolio’s style and ensures alignment with the fund’s stated philosophy.
Actionable Insights: Helps managers adjust portfolios to maintain the desired style.

42
Q

disadvantages of hsba

A

Requires detailed and up-to-date information on all holdings.
Historical analysis may be challenging without point-in-time databases.
Less effective for funds with significant derivative positions.

43
Q

strenghts of rsba

A

Ease of Use: Can be applied without knowing the portfolio’s specific holdings.
Constraints: Models often limit aggressive style identification (e.g., deep value or micro-cap).
Applicability: Widely used but less granular than holdings-based analysis.

44
Q

disadvantages of rsba

A

Data limitations and statistical flaws can lead to inaccuracies.
Derivative-heavy portfolios are harder to analyze using holdings-based methods.

45
Q

how is manager alpha achieved?

A

Security selection.
Factor timing.

46
Q

Building blocks of portfolio construction

A
  • rewarded factor weighting
  • alpha skillzz
  • position sizing
47
Q

what is slippage?

A

the difference between execution price and the bid-ask midpoint, reflects both volatility costs and market impact.

48
Q

Advantages of factor based strategies

A

These strategies can potentially offer better returns or lower risk compared to broad market indexes. They are also transparent, as investors can clearly see which factors the strategy is targeting.

Factor Rotation: Investors can change their exposure to different factors as market conditions change, making it more flexible than traditional passive investing.

49
Q

equitizing

A

Equitizing is a strategy where managers convert cash or other assets into an equity position. For example, if a manager wants exposure to a specific index but holds cash, they might use futures contracts or ETFs to replicate the index’s performance.

50
Q

what is tracking error?

A

Tracking error measures how closely a portfolio’s performance follows its benchmark index. It shows how much the portfolio’s return deviates from the index return.

51
Q

How can the investment manager’s universe be segmented

A
  • segmentation by size and style
  • segmentation by geography
  • segmentation by economic activity
52
Q

Costs associated with owning and managing an equity portfolio

A
  • Management fees
  • Performance fees
  • Administration fees
  • Marketing and distribution costs
  • trading costs
53
Q

Rationales for positioning an equity portfolio along the passive active spectrum.

A
  • Confidence in ability to outperform
  • Client preference
  • Availability of a suitable benchmark
  • Client-specific mandates
  • Risks and costs of active management
  • Taxes
54
Q

Growth strategy

A

Growth strategies focus on companies that are growing faster than their sector or the overall market.
In addition, growth
investors are typically willing to pay an above average valuation multiple for businesses.

55
Q

Income investing

A

The income investing approach focuses on shares that offer relatively high dividend yields and positive dividend growth rates.

56
Q

Special situations investing

A

The “special situations” investment style focuses on the identification and exploitation of mispricings that may arise as a result of corporate events such as divestitures or spinoffs of assets or divisions or mergers with other entities.

57
Q

How to eliminate confirmation bias

A

Actively seeking out the opinions of other investors or team members and looking for information from a range of sources to
challenge existing beliefs may reduce the risk of confirmation bias

58
Q

how to eliminate illusion of control

A

Investors should seek contrary viewpoints and set and enforce proper
trading and portfolio diversification rules to try to avoid this problem.

59
Q

How to eliminate availability bias

A

Setting an appropriate investment strategy in line with the investment
horizon, as well as conducting a disciplined portfolio analysis with a long-term focus,
will help eliminate any short-term over-emphasis caused by this bias.

60
Q

Eliminate loss aversion

A

A disciplined trading strategy with firmly established stop-loss rules is essential to prevent fundamental investors from falling into this trap

61
Q

eliminate overconfidence

A

Regularly reviewing actual investment records and seeking constructive feedback from other professionals can help investors gain awareness of such self-attribution bias.

62
Q

eliminate regret aversion

A

A carefully defined portfolio review process can help mitigate the effects of regret aversion bias.

63
Q

eliminate anchoring bias

A

Analysts can try to avoid anchoring bias by consciously attempting
to avoid premature conclusions.

64
Q

Eliminate status quo bias

A

Status quo bias can be mitigated by disciplined effort to avoid “anchoring” on the status quo.

65
Q

Eliminate prudence bias

A

This bias can be mitigated
by conscious effort to identify plausible scenarios that would give rise to
more extreme outcomes and to give greater weight to such scenarios in the
forecast.

CFA L3 (11 decks)

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