TOPIC 11 - ACTIVE PORTFOLIO MANAGEMENT

Question 1

what’s a practical issue with portfolio management?

Answer 1

security analysts don’t usually have modest alpha estimates –> if you take them at face value can lead to misrepresentation

Question 2

The Treynor-Black model is a portfolio optimization model that seeks to maximize a portfolio’s Sharpe ratio by

Answer 2

combining an actively managed portfolio built with a few mispriced securities and a passively managed market index fund. The Sharpe ratio evaluates the relative risk-adjusted performance of a portfolio or a single investment against the risk-free rate of return, such as the yield on U.S. Treasury securities.

Question 3

Most investment managers are judged

Answer 3

on performance relative to a benchmark portfolio

Question 4

what reveals the importance of tracking error?

Answer 4

the fact that most managers are judged on performance relative to a benchmark portfolio

Question 5

what’s tracking error

Answer 5

dif btw the excess return on the optimal risky portfolio and excess return on the market index

Question 6

in terms of tracking returns, if we subtract out excess returns on the market we get an expression using index model parametrisation that defines

Answer 6

and look at the extent to which performance diverges period to period against excess returns on the market

Question 7

what does the black litterman model allow portfolio managers to do?

Answer 7

quantify complex forecasts (i.e., views) and apply these views to portfolio construction

Question 8

5 steps in black litterman model

Answer 8

1) Estimate the covariance matrix from recent historical data
2) Determine a baseline forecast
3) Integrate the manager’s private views
4) Develop revised (posterior) expectations
5) Apply portfolio optimisation

Question 9

The Black-Litterman Model is a portfolio allocation model that begins with

Answer 9

modern portfolio theory (MPT) and adds in investor views of expected returns.

Question 10

the MPT model is seen to be limited in that it only

Answer 10

incorporates historical market data and then assumes those same returns going forward.

Question 11

The BL model lets the investor

Answer 11

apply their own views and then optimizes the recommended asset allocation.

Question 12

are the BL and TB models complements or substitutes

Answer 12

complements! but once you reach the optimsiation stage, both models are identical

Question 13

the BL model can be viewed as a generalisation of the TB bc the BL model allows you to adjust expected return from views about alpha values as in the TB model, but it also allows you to

Answer 13

express views about relative performance that cannot be incorporated in the TB model

Question 14

under the BL model are optimal portfolio weights and performance sensitive or not to the degree of confidence in thew views expressed?

Answer 14

highly sensitive!

The validity of hte BL model rests largely upon the way in which teh confidence about the views is developed

Question 15

why isn’t the treynor black model applied in teh field?

Answer 15

bc it results in “wild” portfolio weights, which these extreme weights being a consequence of failing to adjust alpha values to reflect forecast precision

Question 16

when should you use the BL mdoel vs the TB model?

Answer 16

BL model: use for asset allocation

TB model: for management of security analysis with property adjustment of alpha forecast

Question 17

Kane, Marcus, and Trippi show that active management fees depend on what 3 things?

Answer 17

1. the coefficient of risk aversion
2. The distribution of the squared information ratio in the universe of securities
3. The precision of the security analysts

Question 18

Treynor-Black portfolio weights are sensitive to

Answer 18

large alpha values, which can result in practically infeasible long/short portfolio positions.

Question 19

The full-blown Markowitz optimal risky portfolio is ….. to assumptions for expected return

Answer 19

extremely sensitive to assumptions for expected return.

Question 20

constraining tracking risk (ie the variance of the return dif btw the managed and benchmark portfolio) acts to keep

Answer 20

the Treynor-Black portfolio within reasonable weights

Question 21

Alpha forecasts must be …. to account for ….

Answer 21

shrunk (adjusted towards 0) to account for less-than-perfect forecasting quality.

Question 22

Compiling past analyst forecasts and subsequent realisations allows one to

Answer 22

estimate the correlation between realisations and forecasts.

Question 23

Regression analysis can be used to measure the

Answer 23

forecast quality and guide the proper adjustment of future forecasts.

Question 24

When alpha forecasts are scaled back to account fo forecast imprecision, the resulting portfolio positions become

Answer 24

far more moderate.

Question 25

The Black-Litterman model allows the private views of the portfolio manager to be

Answer 25

incorporated with market data in the optimisation procedure.

Question 26

5) The Treynor-Black and Black-Litterman models are complementary tools. Both should be used. The TB model is more geared

Answer 26

toward security analysis, while the BL model more naturally fits asset allocation problems

Question 27

Even low-quality forecasts are valuable. Almost imperceptible R-squares of only .001 regressions of realisations on analysts’ forecasts can be used to

Answer 27

substantially improve portfolio performance.

Question 28

Views about the relative performance of bonds compared to stocks can have a

Answer 28

significant impact on how security analysis is conducted

Question 29

For example, as a result of a predicted decrease in interest rates, bonds are now expected to perform better than previously expected. This performance forecast may also reflect forecasts about the quality (credit) spreads for bonds. In addition to the implications of macro forecasts, the play on yields can have important implications for corporations in financial distress with high leverage. The hierarchy of use of the model suggests

Answer 29

a top-down analysis, starting with the BL model inputs. This does not rule out feedback in the opposite direction if, for example, the preponderance of security analysis suggests an unexpectedly good (or bad) economy (or economic sector).