Investment Philosophies and Styles

Question 1

Risk Factor Investing

Answer 1

• portfolio methodology that allocates investment based on risk characteristics and exposures (called “factors”)
• this is a different way to optimize compared to MPT and MVO
• the primary goal is to create a smoother, more efficient return experience and one that weathers overall market volatility more effectively

Question 2

Factor Analysis

Answer 2

 Method for analyzing risk and performance characteristics beyond the traditional asset classes
Common macroeconomic factors include: growth, real rates, inflation, credit quality and spreads, liquidity
 Common style factors include: value, momentum, volatility, quality, size and carry

Question 3

Anomalies/Styles/Characteristics

Answer 3

Systematic sources of return:
market beta
size (capitalization)
value and growth
momentum
volatility/defensive/quality
domestic vs. international/emerging

Question 4

Value vs Growth

Answer 4

• Over many decades, average return of value stocks is much higher than that of growth stocks
– but doesn’t appear to be riskier
• Value stocks (with low ratios) appear to earn higher returns than they “deserve,” for their risk
• Growth stocks (with high ratios) appear to earn lower returns than they “deserve,” for their risk

Question 5

Style Premium: Value

Answer 5

Equity valuations can be quantified by the ratio of a fundamental anchor like book value, earnings or cash
flows over price.

Question 6

Style Premium: Momentum

Answer 6

momentum is the idea that assets that have recently outperformed will tend to do better than assets that have recently underperformed.
Importantly, the returns of the momentum premium have tended to be negatively correlated to those of the value premium

Question 7

Style Premium: Defensive

Answer 7

Defensive stocks tend to be low risk, stable or safe. As with most factors, there is more than one way to
characterize a defensive company from purely fundamental measures such as profitability and general
quality to statistical measures such as low beta and low volatility.

Question 8

Limits to Arbitrage

Answer 8

If stocks are mispriced, why doesn’t the arbitrage process eliminate the inefficiency?
Sentiment risk
•The risk that mispricing will get worse in the short run
•Intermediary investors are evaluated frequently
–danger is that if the mispricing worsens, even temporarily, primary investors will withdraw funds
–knowing this, the intermediary investors don’t take too aggressive a position against the mispricing, allowing it to survive
•Sentiment risk is a very real phenomenon

Question 9

ESG & SRI

Answer 9

There are no clear conclusions on whether these types of funds deliver outperformance (data is conflicting at best) compared to the market as a whole.

Question 10

Measuring Tax Impact and Efficiency

Answer 10

• Capital Gains Realization Rate: the percentage of the fund’s net unrealized capital gains that the manager chose to realize (CGRR = CGDIST/GAINSTOCK)
• Portfolio Turnover Rate: a simple measure of potential taxation, but not usually the best measure of tax efficiency. calculated by dividing the net assets or investments bought and sold by the portfolio value
• Relative Wealth Measure: the higher the better; zero indicates little tax impact; RWM works in all kinds of markets. Good for SMAs. RWM = [(Rat -Rbt ) / (1 + R bt )] x 1,000
• Consultant Capture Ratio: captures the percentage of return that taxable investors retain (after tax return divided by before tax return); works well is smooth, upward trending markets
• Accountant’s Ratio: equals the ratio of short term capital gains realized to total capital gains realized

Question 11

Pair wise Trades

Answer 11

Example: sell asset at a loss ( to harvest tax losses ) and buy a comparable, but not identical, asset to maintain risk exposure while avoiding wash sale rules

Question 12

Asset Location

Answer 12

an exercise in which investors place certain assets and investments, based on tax status and preferences,
into different accounts (e.g., taxable, tax deferred, or tax exempt) in order to minimize taxes during the
growth and distribution phases of each account
•Taxable accounts
–Index and other passive funds
–Growth funds with low turnover
–Tax managed funds
–REITs (could be better for either type of
–Municipal bonds
•Tax deferred accounts
–Dividend stocks
–Most taxable bonds
–Actively management, high turnover funds
–Partnerships “IF” they avoid UBTI