Portfolio Management Flashcards
Authorized participants
(APs) A special group of institutional investors
who are authorized by the ETF issuer to
participate in the creation/redemption process.
APs are large broker/dealers, often market
makers.
Creation basket
The list of securities (and share amounts) the
authorized participant (AP) must deliver to the
ETF manager in exchange for ETF shares.
The creation basket is published each
business day.
Creation/redemption
The process in which ETF shares are
created or redeemed by authorized
participants transacting with the ETF
issuer.
Creation units
Large blocks of ETF shares transacted
between the authorized participant (AP) and
the ETF manager that are usually but not
always equal to 50,000 shares of the ETF.
iNAVs
ndicatedÓ net asset values are
intraday Öfair value estimates of an
ETF share based on its creation
basket.
Redemption basket
The list of securities (and share amounts) the
authorized participant (AP) receives when it
redeems ETF shares back to the ETF manager.
The redemption basket is published each
business day.
Describe factors affecting ETF bid–ask spreads.
ETF spreads are positively related to the cost of creation/redemption, the spread on the underlying securities, the risk premium for carrying trades until close of trade, and the APs’ normal profit margin. ETF spreads are negatively related to the probability of completing an offsetting trade on the secondary market. Creation/redemption fees and other trading costs can influence spreads as well.
Describe sources of ETF premiums and discounts to NAV.
ETF premium (discount) % = (ETF price – NAV) / NAV
Sources of premium or discount include timing difference for ETFs with foreign securities traded in different time zones and stale pricing for infrequently traded ETFs.
Describe types of ETF risk.
Risks of investing in ETFs include counterparty risk (common for ETNs), fund closures, and expectation-related risk.
Describe costs of owning an ETF.
ETF costs include trading cost and management fees. Short-term investors focus on lower trading costs while longer-term, buy-and-hold investors seek lower management fees. Trading costs tend to be lower for more-liquid ETFs. Liquidity is evaluated using the ratio of average dollar volume to average assets (higher is better).
Explain the creation/redemption process of ETFs and the function of authorized participants.
Authorized participants (APs) can create additional shares by delivering the creation basket to the ETF manager. Redemption is similarly conducted by tendering ETF shares and receiving a redemption basket. These primary market transactions are in kind and require a service fee payable to the ETF issuer, shielding the nontransacting shareholders from the costs and tax consequences of creation/redemption. The creation/redemption process ensures that market prices of ETFs stay within a narrow band of the NAV.
Describe sources of tracking error for ETFs.
Tracking error is the annualized standard deviation of the daily tracking difference. Sources of tracking error include fees and expenses of the fund, sampling, and optimization used by the fund, the fund’s investment in depository receipts (DRs) (as opposed to the underlying shares directly), changes in the index, regulatory and tax requirements, fund accounting practices, and asset manager operations.
Identify and describe portfolio uses of ETFs.
Portfolio uses of ETFs include the following:
- Efficient portfolio management, including liquidity management, portfolio rebalancing, portfolio completion, and transition management.
- Asset class exposure management, including core exposure to an asset class or sub-asset class as well as tactical strategies.
- Active investing, including smart beta, risk management, alternatively weighted ETFs, discretionary active ETFs, and dynamic asset allocation.
Describe how ETFs are traded in secondary markets.
ETFs are traded just like other shares on the secondary markets. Market fragmentation may widen the quoted spreads for European ETFs.
Active factor risk
The contribution to active risk squared
resulting from the portfolio different-than
benchmark exposures relative to factors
specified in the risk model.
Active return
The return on a portfolio minus
the return on the portfolio
benchmark.
Active risk
The standard deviation of
active returns.
Active risk squared
The variance of active returns;
active risk raised to the second
power.
Active specific risk
The contribution to active risk squared
resulting from the portfolio active weights on
individual assets as those weights interact
with assetsÖ residual risk.
Arbitrage
(1) The simultaneous purchase of an undervalued asset or portfolio and sale of an overvalued but equivalent asset or portfolio in order to obtain a riskless profit on the price differential. Taking advantage of a market inefficiency in a
risk-free manner.
(2) The condition in a financial market in which equivalent
assets or combinations of assets sell for two different prices, creating an opportunity to profit at no risk with no commitment of money. In a well functioning financial market, few arbitrage opportunities are possible.
(3) Arisk-free operation that earns an expected positive net profit but requires no net investment of money.
Arbitrage opportunity
An opportunity to conduct an arbitrage; an
opportunity to earn an expected positive net
profit without risk and with no net
investment of money.
Arbitrage portfolio
The portfolio that exploits an
arbitrage opportunity.
Company fundamental factors
Factors related to the company internal performance, such as factors relating to earnings growth, earnings variability, earnings momentum, and financial leverage.
Company share-related factors
Valuation measures and other factors related to share price or the trading characteristics of the shares, such as earnings yield, dividend yield, and book-to market value.