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Banking & Asset Management > Session6 - handout9 - Fund > Flashcards

Session6 - handout9 - Fund Flashcards

1
Q

What are example of assets with low risk and low return?

A

Fixed income

Income

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2
Q

What are example of assets with moderate risk and moderate return?

A

Yield

Balanced

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3
Q

What are example of assets with high risk and high return?

A

Growth

Equity

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4
Q

In the long run, what tends to give the highest return: A growth portfolio with high risk or a Income/balanced portfolio with low/lower risk?

A

The growth portfolio - however, it also depends on when we join the market! but in the long run (+25 years) this holds.

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5
Q

Based on a 95% Confidence Interval, what could be expected as an annual return, based upon the historical stock returns between 1926 - 2014?

(based on slide 7 of the handout)

A

Between -30% to +40%.

There have been more positive years than negative years.

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6
Q

What is the idea of a fund?

A

The fund owners buys shares in the fund which will be used to invest in different assets

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7
Q

What is meant by an “Open-end fund”?

A

» publishes its net asset value everyday
» you can buy or sell shares of the fund at the current price
» anytime shares are bought or sold, the amount of total shares will be edited in order to maintain the prevailing share price.
» Unlimited number of shares available

✓ Effects of supply and demand are in that way avoided, the price is only influenced by the underlying assets.

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8
Q

What is meant by the “Net Asset Value”?

A

Net asset value (NAV): Represents the value of the shares based upon a daily valuation on the assets of the fund

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9
Q

What is meant by an “Closed-end fund”?

A

» issues a limited number of shares in an IPO
» shares are listed on an exchange
» share price does not only reflect the value of the net asset value, also influenced by the market forces of supply and demand

✓ closed-end funds tend to be more volatile than open-end funds.

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10
Q

What is meant by “UCITS”?

A

Undertakings for Collective Investment in Transferable Securities.

Moreover: Investment vehicles that pool investors’ capital and invest that capital collectively through a portfolio of financial instruments such as stocks, bonds and other securities

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11
Q

What does the concept of UCITS provide?

A

» single regulatory regime across the European Union
» for open-ended funds investing
» in transferable securities such as shares and bonds.

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12
Q

What does the concept of UCITS regulate?

A

With a view to defining the highest levels of investor protection, the Directive regulates:
» the organisation,
» management and oversight of such funds,
» and imposes rules concerning diversification, liquidity and use of leverage.

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13
Q

What are the reasons for the UCIT directive? (4 reasons)

A
  • Collective investment vehicles are historically under relatively light regulation. Therefore, the industry has been characterised by high discrepancies and heterogeneity between different funds.
  • This created a vague and risky environment for investors (retail or institutional)
  • The UCITS directive answers to the call for a proper regulatory framework aimed to harmonize and improve the transparency of collective investment vehicles.
  • To ensure adequate diversification of investments and risk management - so that they are appropriate for investment by retail investors without advice.
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14
Q

What is meant by the “European Passport” and the “mutual recognition principle”?

A

1) The European passport allows an approved UCITS to be sold to the general public and registered for distribution in all EU Member States.
2) The “mutual recognition principle” ensures market access for goods that are not, or are only partly subject , to EU harmonization legislation.
3) It guarantees that any good lawfully sold in one EU country can be sold in another

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15
Q

What has happened due to the fact that a UCITS is no longer obliged to follow an authorisation process in each market?

A

It has considerably accelerated the process of launching a UCITS and reduced related costs.

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16
Q

Which funds are the UCITS applied to and under what conditions?

A

1) UCITS I directive is applied to all funds which are located on the territory of a member state of the EU

2) and comply to the following conditions:
» Invest exclusively in quoted, floating assets
» “open-ended” fund
» collects savings in the EU publicly
» The fund respects the requirements of the structure and placement policies

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17
Q

What happens if the funds don’t satisfy these conditons and they want to commercialize its units in another state?

A

If the fund wants to commercialize its units in another state, approval must be requested to the financial authorities of the state applicable

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18
Q

What requirements, about the structure, are involved in the UCITS 1?

A
  • Sufficent Capital by the management company
  • Activities of the managing company needs to be confined by the management of the fund
  • Keeping of the assets of the fund needs to be trusted to only one DEPOSITARY
  • Functions of the managing company and the depositary may not be exercised by the same company
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19
Q

What requirements, about the placement policy, are involved in the UCITS 1?

A

• No liquidity as primary asset
• Derivatives with enough coverage
• 3 Rules - good division of risks:
» No possibility to take control
» No loans (a short-term loan can be authorized up to 10% of the assets)
» No credit granting or guarantees, no shorting neither

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20
Q

With UCITS 3, 2 major directives where introduced, in 2001, what was the first one and what does it constitute?

A

1) The Management Directive 2001/107/EC enables European management companies to get a European passport to operate throughout the EU

» However, this right is limited by the fact that the legislation of most member states indicates that an investment company may only delegate its entire management to a management company located in the same state.

2) Introduction of“simplified” prospectus, in order to make the prospectus understandable to all types of investors.

» New prospectus requirements are also put in place which involve the reporting of extra information regarding the risk profile of the fund.

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21
Q

With UCITS 3, 2 major directives where introduced, in 2001, what was the second one and what does it constitute?

A

The product directive 2001/108/EC states that funds are allowed to invest in products which go beyond the definition of transferable securities (stocks and bonds), like liquid products such as derivatives, money market products and other funds

22
Q

What happened in the Madoff case?

A

The manager set up a Ponzi Scheme.

A Ponzi scheme is a scheme in which gullible public is enticed with the promise of very high returns in a very short time, but is based on paying off the early ‘investors’ from the cash from (hopefully ever
increasing number of) new ‘investors.’

23
Q

Under EU-legislation, what is the responsibility of the custodian?

A

Under European legislation, it is the CUSTODIAN who, in the event of the disappearance of assets, is required to repay the sums entrusted to him.

24
Q

What enabled the authorities to crack the Madoff case?

A

1) Madoff wanted to replicate S&P500 - then the results should have been the same which they weren’t.
2) No volatility - S&P500 had volatility - No replication here
3) At the end, B. Madoff was a sub-custodian of the fund at the same time as a manager, which is however prohibited by European legislation.

25
Q

What where the main players of the Madoff case and what was their purpose?

A
  • Promoter (UBS SA, UBS AG): creates the legal and administrative structure of the investment vehicle & helps raise money for investment activity
  • Asset Manager (Access Management Luxembourg): a company that specialises in portfolio management for funds.
  • Depository (UBS SA, UBS AG) : Independent from the Asset Manager, takes care of the administrative and controlling aspect.
  • Accountant and administrative clerk (UBS Fund Services): computes the Net Assets Value (NAV), executes buy/sell orders and writes information documents for investors.
  • Company auditor (Ernst & Young)
  • Supervisory authority CSSF
26
Q

About the Madoff case, Christine Lagarde sent a message in which she highlighted what?

A

The depositary did not respect his function here - I.e taking care of the deposits

27
Q

What was the view of the UBS in the Madoff case?

A

» The fund was created at the request of investors wishing, knowingly, to invest with Madoff

» It had not delegated the management of the fund to B. Madoff directly (prohibited by European legislation), since it was Access Management who was in charge.

» Luxembourg law would not require the retention of securities but only a duty to monitor.

28
Q

What was the foundings of Markopolos in the Madoff Case?

A

1) First thing he mentioned - correlation is zero but if they replicate S&P500 then it should be 1 or close to it
2) > 96% of months were positive over 1991-2005
3) Madoff’s actual 6% correlation meant his portfolios looked nothing like the index he said he was trying to replicate
4) The Stock Index Madoff said he was replicating had a Sharpe Ratio of .43 - Madoff’s Sharpe Ratio was > 2.1 to a lot higher than that
5) Madoff was > 4.8 times better than the Stocks he was managing against for 18 years which is impossible

29
Q

What are the 3 lessons learned from the Madoff case?

A
  1. 0 – 25% is the proper allocation to hedge funds
  2. Never put all of your eggs in one basket
  3. If you don’t understand an investment strategy don’t invest in it
30
Q

in 2009, UCITS 4 was implemented, what did it bring?

A

1) MIFID: Management company “MiFiD” passports, which makes it possible for the companies to provide services as manager without the necessity to establish in the concerned member state
2) SIMPLIFICATION: Simplification of the procedures for cross-border distribution through a new notification process
3) FRAMEWORK: Framework for the domestic and cross-border mergers of UCITS
4) MASTER-FEEDER STRUCTURES: Introduction of master-feeder structures which facilitate the management of funds through a centralized structure. The “feeder”, represented by one or more investment funds, can invest at least 85% of its activities in another fund known as “master”. The remaining 15% can be invested in financial derivatives or liquid assets
5) KIID: Replacement of the simplified prospectus with a new informative document: Key Investor Information Document (KIID) which presents information that can be easily understood and compared with respect to the UCITS of each Member State

31
Q

What were the advantages of UCITS 4? (3 things)

A
  • Improved information: investors are informed in a straightforward and easy-to-understand format, known as a Key Investor Information Document (KIID)
  • Encourages the creation of larger funds: the directive seeks to make it easier to merge together funds established in different EU countries. These changes are supposed to help produce larger funds that would benefit from economies of scale
  • International standardisation: enables a fund management company based in one EU country to run funds established elsewhere in the EU, which also could produce cost savings if there is no longer a need to set up a management company in each country
32
Q

How do you calculate the annual return performance?

A

by using the geometric mean return: This means that we take each years return + 1 and the take the product sum of the entire period, raised to the power of 1 divided by number of periods. Then minus 1 to get this!!

33
Q

When we invest in a security, what is the value of the NPV?
A) Larger than zero (positive)
B) equal to zero
C) Less than zero (negative)

A

It’s C). This, due to time value of money.

34
Q

The higher the volatility the higher the expected return of the security? Yes or No

A

NO!

35
Q

With respect to the risk aversion, what portfolio should be chosen, if we consider risk and return?

A

The optimal portfolio that gives the maximum amount of return to the least amount of risk.

36
Q

What is meant by PRIIPs?

A

The PRIIPs Regulation requires packaged retail and insurance-based investment products (PRIIPs) to publish a key information document and provide it to retail investors. The intention is to enable retail investors to understand and compare the key features of the product and the risks associated with it.

This is a directive that regulates products within the scope of:
» Investment funds
» Structured products
» Insurance products
» Life insurance products that hold an investment element
» Derivative investments
» Structured deposits

What's out of scope is: 
» Corporate shares held directly
» Sovereign bonds held directly
» Non-life insurance products
» Life insurance products where the benefits are payable on death or incapacity
» Various pension products.
37
Q

What should be included in KIDs?

A

KIDs should include the following information
» the name of the product and the identity of the producer

» the types of investors for whom it is intended

» the risk and reward profile of the product, which includes a summary risk indicator, the possible maximum loss of invested capital and appropriate performance scenarios of the product

» the costs investors have to bear when investing in the product

» information about how and to whom an investor can make a complaint in case there is a problem with the product or the person producing, advising on or selling the product

38
Q

What are the key elements of UCITS 5?

A

1) REVISION of the depositary regime as regards depositary eligibility, duties, responsibilities and liabilities and definition of the conditions in which safekeeping duties can be delegated (aligned with AIFMD)
2) INTRODUCTION of rules governing remuneration policies of UCITS managers in order to prevent conflicts of interest and discourage risk-taking inconsistent with the risk profile of the managed UCITS
3) HARMONIZATION of the minimum administrative sanctions regime across Member States”

39
Q

What is meant by AIFMD and what does it do?

A

Alternative investment funds managers directive

1) To establish an EU-wide harmonised framework for monitoring and supervising risks posed by AIFMs and the AIFs they manage,
2) and for strengthening the internal market in alternative funds.
3) The main reason is to provide a regulatory framework for investment vehicles that do not fall under the UCITS directive and still grant the European Passport or allow for partial trading rights.

Therefore there are full scope AIFM’s or simple AIFM’s

40
Q

What is the difference between AIFMD and UCITS?

A

The difference between AIFMD and UCITS is that UCITS regulates products while AIFMD regulates the management of alternative of funds

41
Q

What are the aims of the AIFMD?

A

» to enhance SUPERVISORY practices among EEA competent authorities and to PREVENT market instability and the build-up of systemic risk in the European financial system

» to IMPROVE investor protection by imposing new depositary standards and enhanced transparency through new investor disclosure rules and mandatory reporting to competent authorities

» to foster EFFICENCY and cross-border competition by deregulating national barriers

42
Q

In terms of MiFID, what is meant by the best execution principle?

A

Best execution principle:
○ If we wan’t to buy an asset from a bank etc - we can do this from different platforms - we are to choose the one that is from the best platform
○ How do determine this? - Usually it is in terms of price or speed, that’s taken into consideration.

43
Q

Explain the MiFID framework

A

1) The MiFID framework is used to protect investors on the financial markets and Promoting fair, transparent, efficient and integrated financial
markets.

»2) protecting investors and safeguarding market integrity by establishing harmonised requirements governing the activities of authorised intermediaries;

3) promoting fair, transparent, efficient and integrated financial markets.

44
Q

The MiFID is a cornerstone on EU’s financial regulations, what does it govern?

A

» provision of investment services in financial instruments by banks and investment firms

» operation of traditional stock exchanges and alternative trading venues

45
Q

In terms of portfolio management, why do some people invest in gold?

A

It’s because gold has a correlation with the market that is very close to zero as gold is 100% unsystematic from the market. This makes the asset a good alternative for diversification from the market for the purpose of managing risk.

46
Q

If we were to chose between 2 stocks, A has lower return and volatility, while B has a higher return and volatility, how do we decide?

A

Calculate the Sharpe ratio to see which stock that gives the highest amount of return for each volatility given.

47
Q

What is the link between CAPM and correlation?

A

CAPM: ri = rf + Beta(rm - rf)
Could be equal to: Beta = (ri - rf) / (rm - rf)
In which we can write: Beta = Corr ri/rm

48
Q

What is Beta and what are the two determinants?

A

It is the slope of a regression and the two determinants are:

1) The correlation of the security with the market.
2) the volatility of the security relative to the volatility of the market.

49
Q

What are the three forms of market efficency?

A
  • Weak form: prices reflect all information contained in the history of past trading
  • Semi-strong form: prices reflect all publicly available information
  • Strong form: prices reflect all relevant information, including inside information.
50
Q

Should you be skeptical of hot tips?

A

since, if the stock market is efficient, it has already priced the hot tip stock so that its expected return will equal the equilibrium return.
─ Thus, the hot tip is not particularly valuable and will not enable you to earn an abnormally high return.
─ As soon as the information hits the street, the unexploited profit opportunity it creates will be quickly eliminated.
─ The stock’s price will already reflect the information, and you should expect to realize only the equilibrium return.

51
Q

Do stock prices always rise when there is good news?

A

» NO. In an efficient market, stock prices will respond to announcements only when the information being announced is new and unexpected.

» So, if good news was expected (or as good as expected), there will be no stock price response.

» And, if good news was unexpected (or not as good as expected), there will be a stock price response.

52
Q

Efficient Markets prescription for investing

A

1) Investors should not try to outguess the market by constantly buying and selling securities due to commissions costs on each trade.
2) Instead, the investor should pursue a “buy and hold” strategy— purchase stocks and hold them for long periods of time - same returns without commissions
3) EMH indicates that no mutual fund can consistently outperform the market, an investor should not buy into one that has high management fees or that pays sales commissions –> Buy ETF’s

Banking & Asset Management (11 decks)

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