Investment management Flashcards
What is active investment management?
➢ Manager has few restrictions on the choice of investments
i. Broad benchmark of assets
➢ Enables the manager to make judgements=> future performance of individual
investments
➢ Expected to produce greater returns=> unless market is efficient
➢ Greater risk and dealing costs
What is passive investment management?
➢ Holding assets that closely reflect those
➢ Underlying a certain index or specific benchmark
➢ Manager has little freedom to choose investments
➢ Risks=> tracking error or index performs badly
What factors should be considered before making a tactical asset switch?
➢ Extra return relative to the extra risk taken
➢ Constraints on changes that can be made to the portfolio
➢ Expenses of making the switch
➢ Problems of switching a large portfolio of assets=> price shifting
➢ Tax implications=> crystallising capital gains
➢ Difficulty of carrying out the switch at a good time
➢ Level of free assets
What is risk budgeting?
➢ Process of assessing how much risk should be taken
➢ Where it is most efficient to take the risk=> max return
➢ Two components of the risk budgeting process:
i. Deciding how to allocate the maximum permitted overall risk between active risk and strategic risk
ii. Allocating the total active risk budget across the component of portfolios
1. SA equity manager, SA bond manager
➢ Risk budgeting=> Investment style where asset allocations are based on the asset’s risk contribution to the portfolio as well as on the assets contribution to expected return
What is strategic risk?
➢ Risk of underperformance if the strategic benchmark does not match liabilities
What is structural risk?
➢ Risk of underperformance if the sum of the individual benchmarks given to fund
managers does not add up to the strategic benchmark
What is active risk?
➢ Risk of underperformance if the fund managers do not invest exactly in line with
the individual benchmarks that they are given
What are the key determinants deciding how much strategic and active risk to take?
➢ Strategic risk=> risk tolerance of stakeholder in the fund
➢ Systematic risk that they are prepared to take on in an attempt to enhance longterm returns
➢ Active risk=> whether it believes that active management generates positive
excess returns
9) What are two conflicting objectives faced by an investment fund established to cover
liabilities?
➢ Ensure security
➢ High long term investment returns
Why should a provider’s investment strategy be regularly monitored?
➢ liabilities change over time
➢ funding level of a scheme or free asset position of a company change over time
➢ Monitoring helps identify whether fund managers performance is line with other
funds
11) What are the considerations when setting investment performance objectives?
➢ An investment fund=> compared against similar funds
i. Similar investment objectives
ii. Similar restrictions on fund manager
➢ Return that would have been achieved by an index fund=> maintained same asset
allocation proportions set in the fund manager’s benchmark
➢ Note any other constraints on the manager=> shortage of cashflow timing of
investment or disinvestment
12) What are two methods of measuring active risk?
➢ Historic (backward looking) tracking error=> annualised standard deviations
difference between actual and benchmark returns
➢ Forward-looking tracking error=> estimated standard deviation of relative returns
if current portfolio was unaltered
13) What are other investment risks?
➢ Strategic asset allocation risk=> measured using forward- or backward-looking tracking error approaches
i. Comparing strategic allocation with target allocation
➢ Duration risk=> forward looking or backward-looking tracking approaches
➢ Counterparty interest rate and equity market risk=> Amount of capital needed to
be held against that particular risk=> compared against the amount of capital
required to be held for a target portfolio
➢ ALLOWANCES for benefits of diversification across risks should be made
14) What are two methods of measuring the rate of return on an investment portfolio?
➢ Money weighted rate of return
i. MWRR
ii. Discount rate at which
iii. PV(INFLOW)=PV(OUTFLOW)
iv. Allows for all cashflows and their timing
➢ Time-weighted rate of return
i. TWRR
ii. Compound growth rate
iii. Unit of investment over the period being measured
iv. Product of growth factors between consecutive cashflows
v. That is between periods when there is no cash inflow or outflow from the
fund
15) What is the main disadvantage of the MWRR and TWRR?
➢ MWRR=> Places greater weights on the performance when the portfolio size is
largest
i. IF a manager outperforms the benchmark for a long period of time when the fund is small, but after a large inflow has a short period of underperformance, the MWRR might not treat the fund manager fairly over the whole period.
➢ TWRR=>Will not identify the manager who is skilled at managing small funds
and weak at managing large funds and vice versa
i. Large data requirement is required TOO
