Portfolio Management Flashcards
Before-Tax Alpha Hurdle
The tax adjusted alpha hurdle for a traditional equity manager is 3.0% needed to outperform a passive or indexed alternative.
Capital Gains Realization Rate
- The percentage of the fund’s net unrealized capital gains that the manager chose to realize
- CGRR = CGDIST/GAINSTOCK
Consultant Capture Ratio
- Captures the percentage of return that taxable investors retain.
- Works well in smooth, upward-trending markets
Relative Wealth Measure
- The higher the better; zero indicates little tax impact
- RWM works in all kinds of markets
- RWM is particularly helpful when analyzing separately managed accounts
Accountant’s Ratio
- Equals the ratio of STCG realized to total capital gains realized
- The logic behind this measure is that if a manager is realizing many STCG the manager may not be considering the tax consequences of trading decisions.
Alternative Investments
- Potential Benefits: diversification, hedging, performance, innovation, leverage, etc.
- Risks/Disadvantages: lock-up periods, high fees, taxes, lack of transparency, reporting standards, less regulation, risk of total loss, leverage, volatility, illiquidity, etc.
Contango & Backwardation
- Backwardation is desirable for investors who are “net long,” occurs when futures prices are lower than spot prices, indicates short supply
- Contango occurs when futures prices are higher than spot prices, indicates immediate supply
J-Curve Concept
The expectation that for some investments, such as private equity, there are negative cash flows for several years before leading to positive cash flows in later years.
“Vintage Year” Concept
Vintage year refers to the first (initial) year of investment
Master Limited Partnerships
- Limited partners typically provide the investment and general partners typically manage operations.
- Legal classification includes requirement that 90% of cash flow comes from real estate, commodities, or natural resources (there are exceptions).
- Many MLPs are not appropriate for tax-deferred accounts because of UBTI and other tax related issues.
Backfill Bias
- Hedge funds report returns only if they choose to, and they may do so only when their prior performance is good
Survivorship Bias
- Failed funds drop out of the database
- Hedge fund attrition rates are more than double those for mutual funds
High water mark
– The fee structure can give incentives to shut
down a poorly performing fund
• If a fund experiences losses, it may not be able to charge an incentive unless it recovers to its previous higher value
• With deep losses, this may be too difficult so the fund closes
Unrelated Business Taxable Income (UBTI)
Can create current tax liability (and possible re-characterization) for tax-deferred accounts due to gains realized from investment activities such as leveraged trading strategies and other gain producing activities not considered directly related to the main function of the entity. Subject to federal and state income tax.
Morningstar Sustainability Rating
Measures how well the companies held in a portfolio are managing their ESG risks and opportunities relative to portfolios within their same category
Diversification
To reduce (non-systematic, diversifiable) risk; diversification relies on less than perfect correlation among assets
Mean-Variance Optimization (“MVO”)
- Process or method that measures the efficiency of various mixes of assets or investments that seeks the optimal combination of choices through diversification that minimizes risk per unit of return gained
- Helps quantify risk and return to build optimal portfolios; can help manage risk; aligns an investor’s attitude and aptitude for taking risk with an appropriate mix of assets (advantage)
- Assumes investors are rational; assumes history of risk and return characteristics are reasonable predictors of future performance; assumes fundamental characteristics of capital markets will remain the same; does not incorporate the potential for major shocks to economies or financial markets (Disadvantage)
Dynamic Asset Allocation
A method of changing the allocation of the portfolio based on market conditions. Many advisors and investors find it difficult to adhere to a strategic asset allocation policy. Dynamic asset allocation is assumed to outperform a constant mix portfolio especially during extended bull or bear markets. Most investors are more worried about downside risk then their gains. Because of this a dynamic asset allocation approach may be preferred. Dynamic asset allocation may reduce risk without giving up performance in the long run but may take considerable time to learn and implement.
Option Collar
Hedge that involves selling an out of the money call and buying an out of the money put on an underlying asset that has imbedded gains; this strategy intends to lock in profits by buying downside protection while calls are sold to generate income to help pay for this downside protection; properly executed collars preserve capital and the holding period of low cost basis stock
Option Straddles
Investor purchases both a put and call on the same security with the same strike price and expiration; used when an investor believes the stock price will move significantly but does not know which way the stock will go (up or down)
Option Strangles
Investor holds a put and a call on the same asset, with the same maturity, but with different strike prices; used when there is an expectation of large price swings in the underlying asset
Option Spread
A spread is a combination of two or more calls (or two or more puts) on the same stock with differing exercise prices or times to maturity.
Value at Risk
VaR can be used to budget portfolio risk.
Risk Parity Investment Strategies
- Portfolio approach to asset allocation that focuses on the amount of risk units allocated to each investment or asset class as opposed to percentage allocations to asset classes based on MPT and MVO
- Asset allocation should be designed to balance risk (although not perfectly)
- Many risk parity portfolios leverage lower risk assets to achieve an acceptable expected return
