Portfolio Management2 Flashcards
What is portfolio management?
The process of harmonizing wealth-building and risk management approaches with clients’ resources and goals.
Name three key areas of focus in portfolio management.
Tax-aware strategies, alternative investments, and portfolio risk management.
What is asset location in tax-aware strategies?
Allocating assets to taxable, tax-deferred, or tax-exempt accounts to minimize taxes during growth and distribution phases.
Name examples of assets suited for taxable accounts.
Index funds, tax-managed funds, and municipal bonds.
What is tax-loss harvesting?
Selling securities at a loss to offset gains elsewhere in the portfolio and reduce tax liabilities.
What are components of tax efficiency?
Tax rates, turnover, tax lot management, and tax gain/loss harvesting.
What is the before-tax alpha hurdle?
A 3% alpha hurdle for equity managers to outperform passive alternatives after taxes.
List some characteristics of alternative investments.
Illiquidity, high fees, low correlation to traditional investments, and often less transparency.
Define ‘contango.’
When futures prices are higher than spot prices, indicating immediate supply.
What is the ‘J-Curve’ concept in private equity?
Initial negative cash flows followed by positive returns over time.
What is diversification?
Investing in various securities or asset classes to reduce unsystematic risk.
Define ‘mean-variance optimization.’
A method to measure the efficiency of various asset mixes to minimize risk per unit of return.
What is tactical asset allocation?
Actively adjusting a portfolio’s allocation based on forward-looking market conditions.
What is a ‘put option’?
A contract giving the holder the right to sell a security at a specified price and time.
Define ‘collar’ in options trading.
Selling an out-of-the-money call and buying an out-of-the-money put to lock in profits while minimizing downside risk.
What is a ‘straddle’ in options?
Buying both a put and a call on the same security with the same strike price and expiration.
Define ‘systematic risk.’
Risk affecting the entire market, which cannot be diversified away.
What is ‘beta’?
A measure of systematic risk indicating an asset’s sensitivity to market movements.
What is ‘R-squared’ in portfolio analysis?
Proportion of variation in portfolio returns explained by a benchmark.
What does the Sharpe ratio measure?
Risk-adjusted return, considering total risk (standard deviation).
What does the Sortino ratio emphasize?
Risk-adjusted return, focusing only on downside risk.
What is Jensen’s Alpha?
A measure of portfolio performance based on excess returns over the CAPM expectation.
Define ‘Environmental, Social, and Governance (ESG) investing.’
Investing in companies based on environmental, social, and governance criteria.
What is the Morningstar Sustainability Rating?
A measure of how well a portfolio’s companies manage ESG risks and opportunities.
What is the formula for holding period return (HPR)?
(P_1 - P_0 + D_1) / P_0, where P_0 is the initial price, P_1 is the ending price, and D_1 is dividends received.
How is geometric mean different from arithmetic mean?
The geometric mean accounts for compounding and tends to be lower than the arithmetic mean.
What is the time-weighted return (TWR)?
A method of measuring returns that eliminates the impact of cash flows.
What are wash sale rules?
IRS rules that prevent claiming a tax loss if the same or substantially identical security is repurchased within 30 days.
Name five tax lot methods.
FIFO (First In, First Out), LIFO (Last In, First Out), HIFO (Highest In, First Out), Average Cost Basis, Specific Lot Identification.
What is the capital gains realization rate (CGRR)?
The percentage of a fund’s net unrealized gains realized during a period.
What is the accountant’s ratio?
The ratio of short-term capital gains to total capital gains realized in a period.
What is a master limited partnership (MLP)?
A limited partnership publicly traded on an exchange, primarily focused on real estate, commodities, or natural resources.
What is the ‘vintage year’ in private equity?
The year when the initial investment in a fund is made.
What are structured products?
Customized investment instruments combining traditional assets (stocks/bonds) with derivatives.
Name four hedge fund strategies.
Long/short equity, market neutral, event-driven, and global macro.
What is the key benefit of risk budgeting?
Allocating risk across investments to optimize portfolio risk and return characteristics.
Define ‘risk parity.’
An asset allocation strategy where risk is distributed equally across asset classes, often leveraging low-risk assets.
What is factor analysis?
Analyzing risks and returns based on macroeconomic or style factors like value, momentum, or inflation.
What is a vertical spread?
An options strategy involving the purchase and sale of two options with the same expiration but different strike prices.
What is a horizontal spread?
A strategy involving options with the same strike price but different expiration dates.
What is a diagonal spread?
A combination of vertical and horizontal spreads, involving different strike prices and expiration dates.
What is a buy-write strategy?
Selling call options against a portfolio’s underlying holdings to generate additional income.
What is the impact of survivorship bias in hedge fund performance?
Skews results upward by excluding failed funds that no longer report performance.
Define ‘backfill bias.’
Positive skew in performance results when funds only report returns after achieving favorable performance.
What is the high-water mark in hedge fund fees?
A benchmark ensuring performance fees are only charged on gains exceeding the highest prior value.
What is the required rate of return formula (CAPM)?
r = r_f + β(r_m - r_f), where r_f is the risk-free rate, r_m is the market return, and β is the asset’s beta.
How do you calculate real return (inflation-adjusted)?
Real Return = (1 + Nominal Rate) / (1 + Inflation Rate) - 1.
What is internal rate of return (IRR)?
The discount rate at which the net present value of cash flows equals zero.
Compare dollar-weighted return (DWR) and time-weighted return (TWR).
DWR accounts for cash flow timing and magnitude, while TWR isolates portfolio performance from cash flows.
What does standard deviation measure?
Total risk by assessing the variation of returns around the mean.
How is covariance used in portfolio management?
Measures how two assets move in relation to each other, aiding diversification analysis.
What does the correlation coefficient indicate?
The strength and direction of the relationship between two assets’ returns.
What is R-squared in portfolio performance?
The percentage of a portfolio’s returns explained by its benchmark.
What is the Treynor ratio?
A risk-adjusted return metric that uses beta (systematic risk) to evaluate portfolio performance.
What is the information ratio (IR)?
Measures a portfolio manager’s ability to generate excess returns relative to a benchmark per unit of tracking error.
How is Jensen’s Alpha calculated?
Alpha = R_a - [R_f + β(R_m - R_f)].
What is the goal of ESG investing?
To align investments with environmental, social, and governance principles while potentially achieving competitive returns.
What is inclusionary vs. exclusionary ESG screening?
Inclusionary adds ESG-positive companies, while exclusionary avoids industries like tobacco or fossil fuels.
What is the Morningstar Sustainability Rating?
A ranking of portfolios based on how well their companies manage ESG risks and opportunities.
What is liability-driven investing (LDI)?
Matching portfolio returns and availability with current and future liabilities.
What is goal-driven investing?
Structuring portfolios to achieve specific client objectives, focusing on absolute returns rather than benchmarks.
What are pair-wise trades in tax management?
Selling an asset at a loss to harvest tax losses and buying a comparable but not identical asset to maintain exposure while avoiding wash sale rules.
What is tax-efficiency in portfolio turnover?
Lower turnover tends to result in greater tax-efficiency due to reduced realization of taxable events.
What is the Consultant Capture Ratio (CCR)?
The ratio of after-tax return to before-tax return, showing the percentage retained by taxable investors.
What does ‘tax-aware portfolio rebalancing’ involve?
Rebalancing portfolios with consideration of tax consequences to minimize taxable gains.
What is contango’s impact on investors?
It creates a negative roll yield for investors rolling forward contracts in commodity markets.
Why are alternative investments often illiquid?
They include assets like private equity or hedge funds that have limited secondary markets or lock-up periods.
What are structured products?
Pre-packaged investments that combine securities, such as bonds, with derivatives to achieve specific outcomes.
What is the purpose of incorporating alternative investments in portfolios?
To diversify, hedge risks, and enhance returns by including uncorrelated asset classes.
What is the goal of dynamic asset allocation (DAA)?
To adjust portfolio allocations based on market conditions, potentially reducing volatility and downside risk.
What is the difference between systematic and unsystematic risk?
Systematic risk affects the entire market and is non-diversifiable, while unsystematic risk is specific to a company or industry and can be diversified away.
Define ‘factor-based investing.’
An investment strategy targeting macroeconomic or style factors like momentum, value, and size to enhance returns.
What is risk budgeting in portfolio management?
Allocating risk to investments based on their contribution to overall portfolio volatility.
What is the primary purpose of a collar strategy?
To hedge downside risk while capping upside gains, often used for low-cost basis stock protection.
When is a strangle strategy used?
When an investor expects significant price movement but is unsure of the direction.
What is the benefit of a vertical spread?
It allows for profit in directional markets while limiting risk by capping potential losses.
How does a horizontal spread differ from a vertical spread?
Horizontal spreads profit from time decay, whereas vertical spreads profit from price movement.
What does the Sharpe ratio use to measure risk?
Total risk, represented by standard deviation, to assess performance per unit of risk.
How does the Sortino ratio improve on the Sharpe ratio?
It focuses solely on downside risk, using semi-standard deviation instead of total standard deviation.
What is the significance of Jensen’s Alpha in portfolio analysis?
It isolates the value added by a manager’s skill in security selection and market timing beyond market returns.
What is the information ratio (IR)?
A measure of a portfolio manager’s consistency in generating excess returns relative to a benchmark.
What are ESG funds designed to achieve?
Aligning with environmental, social, and governance goals, while potentially delivering competitive returns.
What is the main challenge in ESG investing?
Conflicting data on whether ESG investments outperform or underperform the broader market.
How does shareholder advocacy fit into SRI?
Investors engage with companies to influence positive changes in environmental, social, and governance practices.
How is geometric average calculated?
By taking the nth root of the product of 1 + return for each period, minus 1.
What is the difference between time-weighted and dollar-weighted returns?
Time-weighted returns eliminate the effect of cash flows, while dollar-weighted returns consider their impact.
Why is the holding period return (HPR) important?
It measures the total return over a specific period, considering price changes and dividends.
How is the geometric mean return calculated?
By taking the nth root of the product of ( 1 + return ) for each period, minus 1.
Why is covariance critical for diversification?
It indicates how two assets move together, helping identify diversification opportunities.
How does correlation impact portfolio diversification?
Lower correlation between assets increases the potential for risk reduction through diversification.
What does a beta of 1.0 signify?
The asset moves in perfect proportion with the market.
What is strategic asset allocation?
A long-term investment strategy that maintains a fixed mix of asset classes, adjusted only for major changes in goals or risk tolerance.
How does tactical asset allocation differ from strategic allocation?
Tactical allocation involves short-term adjustments based on market opportunities or risks.
What is the primary benefit of goal-driven investing?
It measures success by the achievement of specific client goals rather than relative performance against benchmarks.
