Investment management

Question 1

Active and passive investment management

Answer 1

Active: actively seeking out for over/under-priced assets, which can then be traded in an attempt to enhance investment return
Passive: Holding of assets that closely replicate those underlying a certain index/specific benchmark

Question 2

Factors to consider before making tactical asset switch

Answer 2

1. Expected return relative to the additional risk
2. expenses of making switch
3. Problem of switching a large portfolio
   - changing market value
   - tax liability when capital gain is crystallised
   - difficult to carry out the switch at a good time

Question 3

Risk budgeting

Answer 3

• The process of establishing how much risk should be taken and where it is most efficient to take the risk in order to maximise the return.
• An investment style where asset allocations are based on the risk contribution to the portfolio as well as on the asset’s expected return

The process for investment risk particularly:
1. decide how to allocate the maximum permitted overall risk between the fund active risk and strategic risk
2. allocate total fund active risk budget across the component portfolios

Question 4

Strategic risk

Answer 4

The risk of poor performance of strategic benchmark relative to the value of liabilities
-> This includes the risk of poor performance of strategic benchmark relative to the matched benchmark and the risk of poor performance of the matched benchmark relative to the liability value

Question 5

Active risk

Answer 5

• The risk that the manager allows to take to outperform benchmark
• Standard deviation of the active return
• Depends on whether it is believed that active management generate excess return

Question 6

Active return

Answer 6

The return received by the active investment manager relative to their particular benchmark

Question 7

Structural risk

Answer 7

The risk associated with any mismatch between the aggregate of the portfolio benchmarks and the total fund benchmark

Question 8

Tactical asset allocation risk

Answer 8

The risk of following active investment strategy rather than tracking a benchmark index

Question 9

Historical tracking error/retrospective/backward-looking tracking error

Answer 9

Annualised standard deviation of the difference between the portfolio return and the benchmark return based on the observed relative performance

Question 10

Forward-looking/prospective tracking error

Answer 10

The estimate of standard derivation of returns relative to benchmark that the portfolio might experience in the future if its current structure remains unchanged

Question 11

Duration risk

Answer 11

A portfolio that needs to closely match assorted with liabilities will also have a target and an acceptable range for the duration of fixed interest element