Week 11: Asset Allocation

Question 1

What are the three broad categories of assets an investor’s money be distributed in?

Answer 1

• Cash (no expected return, no expected risk)
• Fixed income (low expected return, low expected risk)
• Equities (high expected return, high expected risk)

Question 2

What are stages of a market (eg. the economy) that can be alternated between?

Answer 2

• Expansion: economic and profit growth [stocks]
• Peak: max economic activity/profit in a cycle
• Contraction: economic and profit decline [out of stocks, into bonds]
• Trough: min. economic activity/profit in a cycle

Question 3

What is the goal of asset allocation?

Answer 3

To be MORE invested in equities between the trough and the peak,

and LESS between invested bettween the peak and the trough

Question 4

What are passive asset allocation strategies?

Answer 4

• Does not attempt to time the market; holds one set of assets for a long period of time

Question 5

What are active asset allocation strategies?

Answer 5

• Gennerally fixed, but may change with changing characteristics of an investor (e.g. age)

Also referred to as tactical/dynamic/integrated asset allocation
- Shift the asset allocation based on short-term expectations for different asset classes

Question 6

List Equity Manager Styles

Answer 6

Growth
- Focus on companies with high revenue growth
- May pay high P/E for exposure to high growth

Value
- Focus on mature companies with stable revenue
- Pay low P/E (share price/earnings per share)

Sector rotation
- Marco driven industry selection (selects industry using macroeconomic indicators to determine which sector is most likely to perform best)

Question 7

List bond manager styles

Answer 7

Interest rate anticipators
- bet on interest rates rising or falling

Term to maturity
- restricted to specific maturities (e.g 3-5 year bonds)

Credit quality
- identify the best yields for a given credit quallity; may bet on credit upgrades/downgrades

Spread traders
- long-short bond strategy betting on yield spends between bonds to rise/fall

Question 8

How is performance evaluated?

Answer 8

Compare total return of investments to an alternative benchmark.

The benchmark may blend different asset classes to reflect the investor’s asset allocation

Question 9

How is benchmark total return calculated?

Answer 9

By the weighted average of two indexes.

Example:
- Portfiolio is 30% bonds, 70% stocks.
- Two indexes: Canadian Bond Index (14% total return) and S&P/TSX Composite Index (35% total return)

Benchmark of total return:
30% * 14% + 70% * 35% = 28.7%
- Portfolio total return was less than the benchmark
- Yes, portfolio manager had value because they picked stocks for us

Question 10

Whats the Sharpe Ratio?

Answer 10

• Used in the evaluation of a portfolio’s risk-adjusted return.
• Measures unit of return per unit of risk
  Return = total return
  Risk = standard deviation

Question 11

What is the Sharpe Ratio formula?

Answer 11

(Rp - Rf) / Sdp

• (Rp - rf) is total portfolio return
• Rp is return on portfolio
• Rf is the risk-free rate
• Sdp is st. dev of portfolio

Question 12

What value is preferred?

Answer 12

Higher sharpe ratio is better.