Portfolio Management Process Flashcards
Portfolio perspective
Evaluating individual investments by their contribution to the risk and return of an investor’s portfolio.
Modern portfolio Theory (MPT)
Diversification allows an investor to reduce portfolio risk without neceddarily reducing the portfolio’s expected return. Equilibrium expected returns for securities and portfolio that are linear function of each security’s or portfolio’s market risk.
Diversification ratio
The ratio of risk of an equally weighted portfolio of n securities to the risk of a single security selected at random from the n securities.
Ex: Average standard deviation of return for n stock is 25% ,and standard deviation of return for an equally weight portfolio of the n stock is 18%.
The diversification ratio is 18/25 = 0.72
▪️There are no diversification benefits if diversification ratio = 1
▪️A lower diversification ratio indicates a greater risk-reduction benefit from diversification.
▪️It works bestwhen financial markets are operating normally.
Investment Policy Statement (IPS)
The details of investor’s investment objective and constraints. The IPS should be updated at least every few years and any time the investor’s objectives or constraints change significantly.
3 steps in portfolio management process
▪️Step 1: Planning
an analysis of the investor’s risk tolerance, return objective, time horizon, tax exposure, liquidity needs, income needs => IPS.
▪️Step 2: Execution
an analysis of the risk and return characteristic of various asset class to determine how funds will be allocated to the various asset types.
▪️Step 3: Feedback
Monitoring the change of asset prices and rebalance the portfo.io periodically in response, adjusting the allocations to the various asset classes back to their desired percentages.
Define Contribution pension plan
A retirement plan in which the firm contributes a sum each period to the employee’s retirement account. In any event, the firm make no promise to the employee regarding the future value of the plan assets.
The investment decision => Employee (assume all risk)
Define Benefit Pension Plan
The firm promises to make periodic payment to employees after retirement.
(The employer assumes the risk)
Buy-side firms
Asset management firms include both independent managers and divisions of larger financial services companies.
Sell-side firms
Broker-dealers and investment banks
Full-service asset manager
offer a variety of investment styles and asset classes.
Specialist asset manager
focus on a particular investment style or a particular asset class.
Multi-boutique firm
A holding company that includes a number of different specialist asset managers.
Active Management
Attempts to outperform a chosen benchmark through manager skill.
Passive Management
Attempt to replicate the performance of a chosen benchmark index.
Open-end fund
Investor can buy newly issued share at the NAV. Newly invested cash is invested by mutual fund managers in additional portfolio securities. Investor can redeem their shares (sell them back to the fund) at NAV.
