Section III.C. Flashcards
What is Risk Factor Investing?
- portfolio methodology that allocates
investment based on risk characteristics and exposures (called “factors”) - this is a different way to optimize compared to MPT and MVO
- the primary goal is to create a smoother, more efficient return experience and one that weathers overall market volatility more effectively
What is Factor Analysis?
- Method for analyzing risk and performance characteristics beyond the traditional asset classes
- Often based on “macroeconomic” themes and “style” factors
- Can be used in conjunction with mean variance optimization models
- Common macroeconomic factors include: growth, real rates, inflation,
credit quality and spreads, liquidity - Common style factors include: value, momentum, volatility, quality, size
and carry - The intention is to identify and profit from investment factor strategies
that outperform the market as a whole through timing and/or benefiting from a lack of correlation between these investments
Fama-French-Type Factor Models?
- Market (aka: equity) premium
- Size and book to market ratios explain returns on securities.
- High book to market firms experience higher returns
(value - Smaller firms experience higher returns.
What is “momentum: a fourth factor”?
- The original Fama French model augmented with a momentum factor has become a common four factor model used to evaluate abnormal
performance of a stock portfolio. - Winners minus losers (WML)
winners/losers based on past returns.
Anomalies/Styles/Characteristics - What are Systematic sources of return?
market beta
size (capitalization)
value and growth
momentum
volatility/defensive/quality
domestic vs. international/emerging
Example: Value vs. Growth
- Portfolios of stocks based on
– prices relative to fundamentals
– use price to earnings (P/E) ratio
– could also look at price to book (P/B) and price to cash flow (P/CF) ratios - Over many decades, average return of value stocks is much higher than that of growth stocks
– but doesn’t appear to be riskier - Value stocks (with low ratios) appear to earn higher returns than they “deserve,” for their risk
- Growth stocks (with high ratios) appear to earn lower returns than they “deserve,” for their risk
Style Premium: Value
Value investing is one of the best
known and most studied approaches to outperforming the broader market over the long-term.
Equity valuations can be quantified by the ratio of a fundamental anchor like book value, earnings or cash flows over price.
Style Premium: Momentum
Simply put, momentum is the idea that assets that have recently outperformed will tend to do better than assets that have recently underperformed.
Style Premium: Defensive
- low risk, stable or safe.
As with most factors, there is more than one way to characterize a defensive company from purely
fundamental measures such as profitability and general quality to statistical measures such as low beta and low volatility.
What are the limits to Arbitrage?
If stocks are mispriced, why doesn’t the arbitrage process eliminate the inefficiency?
Sentiment risk
* The risk that mispricing will get worse in the short run
- Intermediary investors are evaluated frequently
– danger is that if the mispricing worsens, even temporarily, primary
investors will withdraw funds
– knowing this, the intermediary investors don’t take too aggressive a
position against the mispricing, allowing it to survive - Sentiment risk is a very real phenomenon
What is Turnover?
High turnover generally results in higher
taxes, but not always.
What is the Capital Gains Realization Rate?
the percentage of the fund’s net unrealized capital gains
that the manager chose to realize
CGRR = CGDIST/GAINSTOCK
What is the “Portfolio Turnover Rate”?
a simple measure of potential taxation, but not usually the best measure of tax efficiency
measures how often assets or investments in a fund or portfolio are bought and/or sold within a specific time period (usually measured annually)
calculated by dividing the net assets or investments bought and sold by the portfolio value (e.g., NAV)
What is “relative wealth measure”?
the higher the better; zero indicates little tax impact
RWM = [(Rat-Rbt ) / (1 + R bt )] x 1,000
RWM works in all kinds of markets
RWM is particularly helpful when analyzing separately
managed accounts
What is Consultant Capture Ratio?
captures the percentage of return that taxable investors retain
CCR = after-tax return divided by before tax return
works well in smooth, upward trending markets
What are the U.S. Tax Rules on gains and losses?
