Trading, Manager Selection And Appraisal Flashcards
Capture ratio greater than 1
Positive assymetry
Convex return profile
Factor model based benchmark
Involve relating a specified set of factor exposures to the returns on an account
Returns based attribution
Returns-based attribution uses portfolio returns to identify the factors that have generated those returns.
Holdings based attribution
Uses beginning of period portfolio holdings to evaluate the decisions that contributed to the returns.
Transaction based attribution
Improves upon the holdings based attribution by including the impact of any trades executed during the evaluation period
Micro attribution
Analyses the portfolio at the portfolio manager’s level. Seeks to verify that the portfolio manager did what they said they would and to understand the drivers of portfolio return
Macro attribution
Analyses investment decisions at the fund sponsor’s level. Commonly used with institutional investing. Has an investment committee which does the SAA and an investment staff which does the TAA and manager selection
POV algorithm
POV Algorithm (Stock Market)
Definition: A Percentage of Volume (POV) algorithm executes trades as a set percentage of the market’s total trading volume.
Purpose: Minimize market impact by aligning trades with natural market activity.
Use Case: Ideal for institutional traders handling large orders.
Example: With a 5% POV, if the market trades 1M shares, the algorithm executes 50,000 shares.
Advantages:
Reduces price slippage
Adjusts dynamically to market conditions
liquidity seeking algorithms
aim to take advantage of favourable liquidity condiitons when offered by the market
arrival price algortihm
seek to trade close to market prices prevailing at the time the order was entered
Smart order routers
Algorithms that determine the best destination to route an electronic order to get the best result.
focus on getting the best price or highest probability of execution for limit orders.
- for small orders
schedule algo when to use
for relatively large orders in liquid markets for managers with less urgency who are concerned with minimizing market impact
when to use liquidity seeking algos
for larger orders in less liquid markets with higher urgency while trying to mitigate market impact
when to use arrival price algos
relatively small orders in liquid markets for managers who believe prices are likely to move against them during the trade horizon, and therefore wish to trade more aggressively. Short term alpha
when dark strategies
- large orders
- illiquid markets
- when arrival price and scheduled algos will lead to higher impact costs
- managers that do not need to execute the order immediately
when SOR algos
Small or orders for best route in prevailing marketing conditions
Clustering
Machine learning technique whereby a computer learns to identify which algorithm is optimal for different types of trades based on the key features of the trades
- grouping similar types of trade
high frequency market forecasting
attempts to model short term market direction
pretrade benchmarks
- decision price
- previous close
- opening price
- arrival price
Intraday benchmark and when used?
- twap
- vwap
Managers without views on short-term price movements who wish to
participate in volumes over the execution horizon
Front running
Front running is when someone, like a broker, secretly buys a stock before a big client order they know will increase the stock’s price. They then sell their shares at a higher price after the client’s trade pushes the price up, making an unfair profit.
Flickering quotes
Flickering quotes are exposed limit orders that electronic traders submit and then cancel shortly thereafter, often within a second. Electronic dealers and algorithmic buy-side traders submit and repeatedly cancel and resubmit their orders when they do not want their orders to stand in the market; rather, they want other traders to see that they are willing to trade at the displayed price.
Bluffing
- Involves actual trades (not just fake orders) to manipulate market perception.
- Often part of pump-and-dump schemes, where traders buy assets to push prices up, lure in momentum traders, and then sell at a profit.
- Can include rumors, misleading information, or wash trading to amplify the deception.
- Example: A trader buys stock, spreads positive rumors, gets others to buy in, and then sells at the inflated price.
Spoofing/layering
- Involves placing fake orders to create an illusion of market demand or supply.
- The goal is to mislead other traders into buying or selling based on false signals.
- The spoofer cancels their fake orders after benefiting from the manipulated price movement.
- Example: A trader places large sell orders to trick others into thinking prices will drop, then cancels them and buys the stock cheaply.
Wash trading
A trader executes a series of trades where they act as both the buyer and the seller. By cycling the same asset through their accounts, they make it appear that the asset is highly liquid or in demand, drawing in unsuspecting investors who assume there’s real market interest.
Winners minus losers
It captures the momentum effect, which is the tendency for assets with strong past performance to continue performing well, and for those with weak past performance to continue underperforming.
High minus low
HML measures the performance difference between stocks with high book-to-market (B/M) ratios (value stocks) and those with low B/M ratios (growth stocks). used for growth and value tilt
Effective spread (trading)
The effective spread is two times the difference between the trade price and the mid-quote price before the trade occurred. The effective spread is a poor estimate of actual transaction costs when large orders have been filled in many parts over time or when small orders receive price improvement.
What are some of the systematic risks posed by electronic traders
Runaway
algorithms that produce streams of unintended orders caused by programming mistakes
Fat finger errors that occur when a manual trader submits a larger order than intended
Overlarge orders that demand more liquidity
than the market can provide,
Malevolent order streams created deliberately to disrupt the markets.
Quote leapfrogging
Quote leapfrogging happens when dealers or traders in a quote-driven market improve their bid-ask prices in response to better quotes from competitors.
Just like in our concert ticket example, quote leapfrogging occurs in trading when dealers or traders quickly adjust their quotes in response to competing offers.
Gunning the market
Gunning the market occurs when a manipulator artificially drives a stock’s price down or up to trigger stop-loss orders or panic selling/buying among traders.
Squeezing the market
A squeeze happens when a manipulator creates scarcity for an asset or stock, forcing certain market participants (like short-sellers) into unfavorable positions.
Cornering the market
This occurs when a person or group gains control over a significant portion of a market or asset, allowing them to manipulate supply and price.
When is downside capture ratio good?
when less than 100%
Type 1 error
Hiring or retaining a manager who subsequently underperforms expectations.
type 2 error
Not hiring or firing a manager who subsequently outperforms, or performs in line with, expectations.
solutions to systematic risk problems from electronic markets
- traders must test software thoroughly before using it in live trading.
- Rigorous market access controls must ensure that only those orders coming from approved sources enter electronic order-matching systems.
- The electronic traders who generate orders and the electronic exchanges
that receive orders must surveil their order flow in real time to ensure that
it conforms to preset parameters that characterize its expected volume, size, and other characteristics. - Some exchanges have adopted price limits and trade halts to stop trading when prices move too quickly.
Return attribution
evaluates impact of active portfolio management decisions on the funds investment
risk attribution
parallel of return attribution but analyzes impact of portfolio managers active investment decisions on portfolio risk
An effective performance attribution process includes
- A reflection of 100% of the portfolio’s return or risk exposure
- The portfolio manager’s current decision making process
- The active investment decisions taken by the portfolio manager
- A full explanation of the portfolio’s excess return and risk
Advantages of SMAs
- Control (direct ownership of underlying security)
- Customization
- Tax efficiency
- Separate reporting
- Greater transparency
Closed ended and ETFs
Highest liquidity, after that comes open ended funds
Hard lock and soft locks
No redemptions - redemptions with a fee
Private equity and VC funds
Lowest liquidity
3 basic forms of performance based fees
1) symmetrical based structure with full upside and downside exposures
- Fee = base + performance sharing
2) Bonus with full upside and limited downside exposures
- Fee = Greater of (1) base, (2) base + sharing of positive performance
3) Bonus with limited upside and downside exposures
=> fee = greater of: (1) base, (2) base + sharing of positive performance (within limit)
Execution risk and how its reduced
- Execution risk—the risk of adverse price movement during the trading horizon
due to a change in the fundamental value of the security
Trading faster (greater trade urgency) results in lower execution risk
Valid benchmark
unambiguous, investable, measurable, appro
priate, reflective of current investment opinions, specified in advance, and
accountable.
Alternative investments are difficult to benchmark, why?
less liquid, have fewer available market benchmarks, and often lack transparency.
2 types of traditional approach
Liquidity based (how liquid they are
performance based (caapital growth, inflation hedging, deflation hedging assets)
Advantages and disadvantages of endowment model
Advantages:
Higher potential for value-added (alpha) due to active management. Diversification benefits from alternative investments.
Disadvantages:
Expensive to implement due to high management fees. Difficult for small and very large investors due to access constraints or large asset size limitations
Advantages and disadvantages of norway model
Low cost and transparent, making it easy for oversight.
Suitable for large-scale funds due to passive management and low complexity.
Disadvantages:
Limited potential for alpha since it relies mainly on market returns. Less diversification compared to alternative-heavy models
Advantages and disadvantages of canadian model
Higher potential for value-added through active management.
Development of internal investment capabilities, reducing reliance on external managers.
Disadvantages:
Potentially expensive due to the costs of building an in-house investment team. Complex to manage, requiring strong governance and expertise
