Michaelmas Term - Lecture 8 Flashcards
What is index management?
This is where you need a positive portfolio strategy but not a market portfolio because of the transaction costs. Instead make a portfolio P that has fewer and more liquid assets and mimics the market portfolio.
What is performance enhancement?
This is a strategy based on evidence that traditional indices are inefficient. You maximise the return relative to the benchmark. The aim is to find appropriate weights.
What is factor tilting?
Factor tilting is an active strategy that involves forming portfolios and looking at forecasts of factors. The factors affect different assets. When we think a change in factor is going to have a positive realisation we load on the asset associated with that factor.
What is the Treynor-Black model?
This is where you form a portfolio of misplaced securities and combine it with the market portfolio to diversify
Where does the Treynor-Black portfolio lie?
On the capital allocation line (CAL). This is above the CML.
How do we assess the performance of our managed portfolio?
Compare the Sharpe ratio of the managed portfolio is the ration of the market portfolio. If the managed portfolio has a higher ration then the manager has outperformed the market.
What is the M^2 measure?
Measure of the returns of portfolios that are managed
When is the Sharpe ratio not appropriate?
When funds are part of a larger portfolio or when deciding how much to compensate managers. In this case we need a measure which looks at the return relative to the systematic risk of the portfolio. Some examples of measures include the; Jensen measure, the Treynor measure and the Appraisal ratio.
What is Jensen’s alpha?
This is the maximum you should be willing to pay a portfolio manager. It is essentially a measure of the manager’s performance. To find it just find the alpha of the CAPM regression.
What is Treynor’s ratio?
This is the expected excess return relative to systematic risk. It is also the slope of the SML for the actively managed portfolio.
Sharpe vs Treynor
The Sharpe ratio looks at total risk and is useful for ranking an entire portfolio. Treynor uses beta for systematic risk and is useful for investments that are part of a larger portfolio.
Treynor vs Jensen
Treynor can be seen as a measure of the ratio of alpha to to systematic risk (beta) so Treynor and Jensen will always agree but will not rank portfolios in the same way.
What is the appraisal ratio?
How much of an asset/fund you want to add to your portfolio. Unlike Jensen and Taylor it is adjusted for idiosyncratic risk.
What measure should you use to calculate how much compensation to pay a manager?
Jensen’s alpha
What measures can you use for optimal portfolio choice?
Sharpe ratio - When the portfolio is the entire fund
Treynor ratio - When the portfolio is one of many within a larger passive portfolio
Appraisal ratio - When the portfolio is to be optimally mixed with the passive portfolio
