Portfolio Construction Flashcards
What is long-term strategic asset allocation
relatively static asset allocation - that will not be changed over the long term
It is a neutral position intented to meet client’s objectives over the long term
Starting point of the portfolio construction process
What is Tactical Asset Allocation
Chasing alpha by under/overweighting asset classes
when contrasted to their long term weights
Give an example of TAA
Manager expects equity to underperform
Underweight equity by 10%, overweight bonds and cash by 5% each.
What is CPPI?
Constant Proportion Portfolio Insurance
What are the three figures used to calculate CPPI?
1) Floor = Amount that must be protected
2) Cushion = Difference between portfolio value and floor
3) Multiplier = 1 / max drawdown %
Pros of CPPI?
1) Useful when a lump-sum (e.g. house deposit) must be protected
2) Does not forego capital gains by only investing in safe assets
3) No leverage = less risk
Cons of CPPI?
1) Stop-loss mechanic takes away potential upside
2) Cushion will be rebuilt slowly after max loss
3) May not capatalise on a market rally after a large fall
4) CPPI will fail if max loss is exceeded
5) Needs regular rebalancing
Pros of SAA
1) Appropriate for a long term investor happy to tolerate risk
2) Sees past short term volatility
3) Inexpensive in terms of trading costs
4) Does not require intensive management
What are some pros of Asset liability approaches?
1) You do not endanger the capital that needs to be protected
2) Leverage can take small capital and generate large returns
3) No rebalancing = low cost and simple
What are some cons of asset liability approaches?
1) VaR figure has to be accurate
2) If interest rates are too high cannot be done
3) Need to have a broker for leverage
What are some pros of core satellite portfolios?
1) Cost efficient
2) Focus on areas where value can be added
3) Lower volatility than fully active
4) More customisation
What are some cons of core satellite portfolios?
1) Increased management (rebalance / research)
2) Additional risk (management, active share etc)
3) Potential for no different result (lags or matches index)
Merits of Risk Parity Allocation
1) Improved Risk-Adjusted Returns
2) Leverage can improve returns
3) Leverage counter balances weight to safe asset
4) Enhanced Diversfication
Cons of Risk Parity Allocation?
1) Leverage can be too high (during high interests)
2) Client may not be able to borrow enough
3) More complex to maintain / rebalance the desired balance.
What does can an ESG screen introduce to a portfolio?
Sector Bias
(screens are not sector neutral)
How to implement a sector neutral screen?
Best in sector positive screen
What risks do money market funds pose vs T-Bills
1) Foreign Currency exposure
2) Invest in companies - can default (FIGs / CORPs)
3) Interest introduces reinvestment risk
4) Counterparty risk from 3rd party fund provider
What real world factors prevent someone from holding the efficient portfolio?
1) Round lot sizes
2) Liquidity / Availability (e.g. foreign controls)
3) Risk management
4) Ethics, Regulation
What flexibilities are given by boards to fund managers to make TAA tilts?
1) Risk Budget
2) Tramlines for Asset Classes
3) Tracking Error
4) Seperate Sleeves
5) bps allocation based on conviction
e.g. 100bps conviction, 200bps strong conviction
What is portfolio dedication?
Structuring a portfolio so that it meets a series of future liabilities.
e.g. zero coupon bonds expiring on liability date
use of fixed income etc.
Give benefits of Smart/Alternative beta indices
1) Underweight large stocks = diversification
2) Not procyclical = better in downturn
3) Can follow a long run factor (e.g. low P/E, momentum etc)
Give cons of Smart/Alternative Beta indices
1) Higher cost
2) Higher risk (active risk)
3) If the factor becomes popular it will dissapear
