Equity Portfolios (Ch7)

Question 1

How can Domestic Equity Funds be categorised? (3)

Answer 1

• size: small/medium/large
• goals: growth/value or blend
• area: sector/industry

Question 2

How can International Funds be categorised? (2)

Answer 2

– Developed/Emerging

– Geographic/Industry

Question 3

What is the Equity Strategy of an index fund?

Answer 3

Follow/ match a benchmark which is a specific market index i.e. SMP, MSCI, CRSP

Question 4

What is the Equity Strategy of a passive fund?

Answer 4

Follow/ match a benchmark which isn’t a market index

Question 5

What is the equity strategy of an Index+/Structured Active Funds/Risk-Controlled Active?

Answer 5

Try to beat/out-perform a benchmark by changing the weightings of assets within the portfolio.

Question 6

Which if the three investment strategies is the cheapest to invest in? the most expensive?

Answer 6

• index fund is the cheapest, not much skill required

- Structured Active Funds are the most expensive, skilled people are needed.

Question 7

How do large and small cap funds act differently?

Answer 7

Large Caps - more diversified, more capital backing, slow to react to market movements
Small Caps - less diversified, more risky, more agile and sensitive to market movements, more growth potential.

Question 8

What is the goal of a passive fund manager?

Answer 8

to minimise the difference in fund returns to the returns of the benchmark, i.e. minimise tracking error

Question 9

What is the formula for tracking error?

Answer 9

TE = delta σ x (sqrt of P)

Where:
P = the number of return periods in a year
σ = standard deviation of the return differential between the return of Fund and the return on a benchmark.

Question 10

How does a growth orientated investor invest?

Answer 10

invest in any asset (small and large cap) as long as they produce “above average earnings”, i.e. earnings larger than expected, so not just small caps but also large caps in market downturns

Question 11

What does a growth orientated investor look at in a company?

Answer 11

companies that are expected to experience rapid growth in their EPS (usually assume that PE ratio will remain constant)

Question 12

How does a value orientated investor invest?

Answer 12

When the price falls you invest, value performs better over long term horizons.

Question 13

What does a value orientated investor look at in a company?

Answer 13

focus on stock prices, must think stock is cheap before they buy. (usually assume that PE ratio is below natural rate and will increase)

Question 14

what does sector rotation refer to?

Answer 14

Shift funds between sectors to take advantage of the next rise in a specific sector. i.e. forecasting the economy, timing hot market sectors can be risky

Question 15

At what stage of the economic cycle does Financial Industry perform well?

Answer 15

Performs best towards the end of the economic downturn as expectation of economy improve and interest rates are low.

Question 16

At what stage of the economic cycle does Consumer Durables (Discretionary) perform well?

Answer 16

As economy begins to recovers, consumers spend more.

Question 17

At what stage of the economic cycle does Capital Goods perform well?

Answer 17

when Business spend more to improve efficiency and reduce costs. Sales improve.

Question 18

At what stage of the economic cycle does Capital Goods perform well?

Answer 18

Cyclical Industries: Rise and fall with economy. Attractive during early stages of recovery. These include heavy industry and durable goods, airlines, car manufacturers etc. Usually come with high operating leverage.

Question 19

At what stage of the economic cycle does Basic Materials perform well?

Answer 19

Attractive at the peak of the business cycle. Inflation is high and demand higher than supply. Energy, metals and other raw material are in demand regardless of inflationary effects.

Question 20

At what stage of the economic cycle does Consumer Staples/Necessities perform well? i.e. pharmaceuticals, food

Answer 20

Counter cyclical firms that provide health care and pharmaceuticals, food, beverage etc. Provide basic necessities, constant throughout, however perform better than other industries in a downturn.

Question 21

What is technical analysis?

Answer 21

Uses historical data to infer future returns.

Question 22

Managers that employ technical strategies assume one of which two things?

Answer 22

• Stock prices will continue in the same direction, price momentum
• Stock price trend will reverse, contrarian strategy.

Question 23

What will managers do if they assume a price momentum vs a contrarian strategy? outline both

Answer 23

• momentum: buy more hot stocks and offload the cold, assuming an under reaction of the market.
• contrarian: buy stock when investors are bearish, sell stock when investors are bullish, assuming an over reaction of the market.

Question 24

what is a recommended market anomaly investment strategy?

Answer 24

investing in small caps based on varies anomalies of the firms themselves

• large variety
• postitive nominal returns

Question 25

what are the 3 steps in the equity investment process?

Answer 25

1 select equity mix
2 decide appropriate equity processes
3 select managers

Question 26

what is equity behaviour based on?

Answer 26

risk and return

Question 27

what is a desired equity mix?

Answer 27

one that includes more than just one type of equity class, i.e. you do not diversify by investing in only small caps or only large caps

Question 28

What is more correlated? style of investing or type of market cap?

Answer 28

style, i.e. growth or value

Question 29

Which equity style and cap offer the highest returns since 2000?

Answer 29

value, especially in the small and medium caps

Question 30

Which equity style and cap have the highest volatility/risk since 2000?

Answer 30

Growth, especially small caps and international, over longer time periods volatility decreases.

Question 31

In which economic state should you invest in growth and when should you invest in value?

Answer 31

• Growth: downturns when growth slows - usually invested in large-caps
• Value: tend to perform better are the economy recovers from a downturn

Question 32

how do you conduct a style analysis of a portfolio? (3 steps)

Answer 32

• compare style groups within portfolio against applicable index which reflects the style
• understand the relationship between the portfolio and the investment style
• understand influences responsible for portfolios performance

Question 33

why conduct a style analysis? (4)

Answer 33

inform clients, performance measurement, allow diversification, all for control

Question 34

does growth or value investment out perform in market downturns?

Answer 34

growth

high risk low return usually but offers hedge in market downturns