LM 4: Basics of Portfolio Planning & Construction Flashcards
What are the 9 major components of an IPS? ISSPIIIEA
-introduction
-statement of purpose
-statement of duties & responsibilities
-procedures
-investment objective
-investment constraints
-investment guidelines
-evaluation & review
-appendices
What is the PURPOSE of the introduction, statement of purpose, statement of duties & responsibilities, procedures, and investment objectives in the IPS?
introduction: describes the client
statement of purpose: states purpose of the IPS
statement of duties and responsibilities: details the duties and responsibilities of the client, the custodian of the clients assets, and the investment managers.
procedures: explains steps to take to keep the IPS current and procedures to follow to respond to various contingencies.
investment objectives: clients return objectives and risk tolerance
What is the PURPOSE of the investment constraints, investment guidelines, and evaluation & review in the IPS?
investment constraints: factors that limit the client in achieving the investment objectives
investment guidelines: how policy should be executed, eg leverage and derivatives, and on specific assets excluded from investment
evaluation & review: guidance on obtaining feedback on investment results
What is the PURPOSE of the appendices in the IPS?
information about strategic asset allocation & rebalancing policy.
What is the difference between absolute risk and relative risk in regard to the IPS?
absolute is spot on must earn 8%
relative is some flexibility vs a benchmark
What’s the difference between ability to take on risk vs willingness to take on risk?
ability is how much financial cushion or age, knowledge, etc.
willingness is the attitude or preference for taking on risk
What is the difference between absolute return and relative return in regards to the IPS?
absolute return is whatever an asset or portfolio returned over a certain period
relative is is the difference between absolute and performance the extra return above a bench mark
What are the 5 constraints to portfolio selection (IPS constraints)?
-unique circumstances
-legal and regulatory factors
-tax concerns
-time horizon
-liquidity
Describe what the 5 constraints to portfolio selection are. LTTLU
liquidity: ability to turn investment assets into spendable cash
time horizon: longer the time horizon the more risk and less liquidity the investor can accept in portfolio
tax concerns: different tax benefits may appeal to different investors
legal & regulatory factors: constraints may restrict investing in particular securities
unique circumstances: religious preferences, ESG, etc.
What are the 6 ESG considerations or ways to decide ESG? NPESTI
-negative (exclusionary) screening
-positive (best in class) screening
-ESG Integration
-shareholder engagement/ active ownership
-thematic investing
-impact investing
What is shareholder engagement/active ownership, thematic investing, and impact investing?
shareholder engagement /active ownership: using shareholder power to achieve ESG objectives
thematic investing: emphasizes single factor such as energy efficiency or climate change
impact investing: seeks to achieve target social or environmental objectives along with measurable financial returns through engagement with company or directly investing in companies
What is negative screening, positive screening, & ESG integration?
negative screening: excluding certain sectors or companies from consideration due to ESG concerns or business activities
positive screening: selecting investments which have favorable ESG characteristics
ESG integration: consideration of ESG factors in asset allocation & portfolio construction
Returns on asset classes are best described as being a function of:
a. the failure to arbitrage
b. exposure to the idiosyncratic risks of those asset classes
c. exposure to sets of systematic factors relevant to those asset classes
c. exposure to sets of systematic factors relevant to those asset classes
What is tactical asset allocation?
an active management portfolio in which they decide to deliberately deviate from the policy portfolio to take advantage of market prices and strengths
Risk assessment questioners for investment management clients are most useful in measuring:
a. value at risk
b. ability to take risk
c. willingness to take risk
c. willingness to take risk
we don’t want to know exactly how much in dollar value, we want to know how willing to take risk.
For an IPS how many years is considered a long term time horizon?
10 or more years.
Whats the difference between systematic risk and unsystematic risk?
Unsystematic risk is a risk specific to a company or industry
Systematic risk is the risk tied to the broader market.
What is capital market expectations and what does it include?
Capital market expectations are the risk and return prospects of asset classes.
includes expected risk & returns, standard deviations, and correlations.
What does homogenous mean?
means the same
What 2 things does the strategic asset allocation combine?
combines the constraints and objectives of the IPS with long-term capital market expectations
What is utility function formula?
U = E(R) - ((1/2)* A* o^2)
E(R) = portfolio expected return
A = risk aversion coefficient
o^2 = portfolio variance
What is risk budgeting?
deciding the amount of risk to take on in a portfolio and subdividing the risk over the return sources
What is the difference between strategic asset allocation and tactical asset allocation?
strategic asset allocation: setting target allocations for various asset classes and rebalances the portfolio periodically.
tactical asset allocation: seeks to add return by varying the weights between asset classes based on forecasts; deviating from strategic asset allocation
What is rebalancing of a portfolio?
adjusting the weightings of the different asset classes in your investment portfolio to match up with the strategic asset allocation set forth in the IPS
What is core-satellite approach?
involves allocating the majority of a portfolio’s assets to passive or low active investments (the “core”) and placing the remaining funds in actively managed “satellite” accounts.
What are 2 new developments in portfolio management?
- Growth in the offering ETF’s with robo-advice
- Risk-parity investing
What is risk parity investing?
creating a portfolio based on certain risk and return levels instead of 60% stocks and 40% bonds. often uses leverage, short selling, etc.
What is Fama French 3 factors and the difference between carhart?
FF proposed that three factors seem to explain asset returns better than just systematic risk. Those three factors are relative size, relative book-to-market value, and beta of the asset.
market risk, (2) the outperformance of small-cap companies relative to large-cap companies, and (3) the outperformance of high book-to-market value companies versus low book-to-market value companies.
market risk, (2) the outperformance of small-cap companies relative to large-cap companies, and (3) the outperformance of high book-to-market value companies versus low book-to-market value companies.
carhart: extends FF and uses momentum (defined as relative past stock returns.)
Who does ROBO ADVICE cater too?
Cater to investors with lower levels of investable assets (mass affluent’ and younger investors.)
