Week 5 - Active portfolio strategies

Question 1

What is the difference between systematic and non-systematic risk factors of an bond index?

Answer 1

Systematic - factor affecting all the bonds in the index (interest rate for example)
Non-systematic - affecting a single bond

Question 2

What is the interest-rate expectations strategy, and how would you achieve it?

Answer 2

A manager who thinks his prediction of future interests-rates is more precise will alter the duration of the portfolio to match his prediction.
You would achivie the change in duration by swapping current bonds for bonds with duration in line with your predcition.

Question 3

What is the difference between parallel and nonparallel shifts of the yield curve?

Answer 3

In parallel shifts the changes in yield apply to all the maturities
While in the nonparallel shifth the changes in yields are different for different maturities

Question 4

What does the flattening/steepening of the yield curve indicates?

Answer 4

It indicates that the yield spread between the yield on a long-term and a short-term Treasury has decreased / increased

Question 5

Historically what two types of nonparallel shifts have beend observed?

Answer 5

Flattening/steepening of the yield curve
Changes in humpedness of the curve

Question 6

What is a yield curve strategy?

Answer 6

Yield curve strategies involve positioning a portfolio to capitalize on expected changes in the shape of the Treasury yield curve

Question 7

What are the 3 different types of yield curve strategies?

Answer 7

bullet strategy: maturities of the securities in the portfolio are highly concentrated at one point on the yield curve
barbell strategy: the maturities of the securities in the portfolio are concentrated at two extreme maturities
ladder strategy: the portfolio is constructed to have approximately equal amounts of each maturity

Question 8

what is a yield spread strategy?

Answer 8

positioning a portfolio to capitalize on expected changes in yield spreads between sectors of the bond market

Question 9

what is a substitution swap?

Answer 9

An exchange of one bond for another bond that is similar in terms of coupon, maturity, and credit quality, but offers a higher yield

Question 10

What are the principles of selecting a becnhmark?

Answer 10

1. Relevance to the investor
   e.g. avoid natural concentration between the sponsor’s business risk and the invested portfolio
2. Representative of the market
   e.g. minimum size thresholds result in different industry / rating distributions
3. Transparent rules and consistent constituents
   Imperative that the rules defining the index are transparent, objective and consistent
   Treatment of downgrades, unrated and split rated bonds have oftentimes violated this principle
4. Investible and replicable
   The index constituents should be a set of bonds that have standard features, are liquid and trade actively
5. High quality data
   Ability to get true market prices for bonds is a common problem because they are traded OTC
   To avoid this pitfall, index pricing needs to be from an accurate and reliable source
6. Independence
   Ideally, provided by an independent and quasi regulatory source
   Less obvious for bonds than for equity

Question 11

How do you create a index using the rule-based approach?

Answer 11

You take already made index and customize it using rules.

Question 12

How do you create an index using the mean-variance analysis?

Answer 12

Setting up the problem: maximum and/or minimum inclusion constraints on assets, the efficient frontier can be solved using iterative software

Question 13

what are the 3 parts of portfolio evaluation?

Answer 13

1. Selection of a benchmark
2. Evaluation of returns
3. Evalution of risks as measured by Tracking Error

Question 14

What is an absolute return portfolio?

Answer 14

is an investment strategy that has no stock- or bond-related benchmarks, can take short positions and is referenced typically vs. Cash (London interbank offered rate)

Question 15

What are the 3 types of benchmarks?

Answer 15

1. Market index or market portfolio
   e.g. S&P500
   transparent, replicable, revisions are rule-based
2. Managed portfolios that are actual portfolios
   e.g. Morningstar’s short-term high-quality bond index
3. Liabilities are the basis for a benchmark

Question 16

what is an attribution analysis?

Answer 16

Trying to attribute the excess return to specific risk factors or deviations from the banchmark

Question 17

What are the 6 key lessons from the meta study we looked at in the class?

Answer 17

1. Improved financial performance due to ESG becomes more noticeable over longer time periods
2. ESG integration as an investment strategy performs better than negative screening approaches
3. ESG investing provides downside protection, particularly during a social or economic crisis
4. Companies’ sustainability initiatives appear to drive better financial performance due to factors such as improved risk management and more innovation
5. Managing for a low-carbon future improves financial performance
6. ESG disclosure without an accompanying strategy does not drive financial performance

Question 18

what are the conclusion of the guest lecture for week 5?

Answer 18

There is a strong negative relation between a fund’s total return and its ESG score, explained by the fact that higher return funds have more exposure to high yield debt which is associated with lower ESG scores.
ESG components matter for alpha:
1. Governance contributes positively to pure alpha while Social / Environmental factors contribute negatively.
2. This differential may reflect sectoral or industry biases (e.g., carbon, fossil fuels) that lead away from higher yields. Note that sectoral biases are less likely to be manifest in governance metrics than in environmental/social.
3. It is possible that ESG funds have lower returns because they have less risk.
Flows into ESG funds have accelerated in recent years and are not spread evenly across sectors and industries; possibility of flow effects