Portfolio Management Pathway

which has lower expense ratios for long-term investors, ETFs or mutual funds?

ETFs

Define overlays and main types.

An overlay is a derivatives position layered on top of an existing portfolio to adjust its risk or return characteristics, without disturbing the underlying holdings.

A completion overlay addresses an indexed portfolio that has diverged from its proper exposure. Typically used to address cash drag.

A rebalancing overlay addresses a portfolio’s need to sell certain constituent securities and buy others.

A currency overlay assists a portfolio manager in hedging the returns of securities that are held in a foreign currency

What are the pros/cons of using derivatives for portfolio management compared to using the cash markets?

With tactical allocation changes, derivatives can change exposure to an index with a single transaction. However, for long-term investors, derivatives require rolling. Derivatives also may not exist on certain securities.

advantage of swaps compared to futures

Swaps are traded otc and thus offer customization on the underlying index, maturity, etc. There is of course more counterparty risk.

Describe how separately-managed equity indices work

Managers first subscribe to a data service from the index provider. The data feeds an order management system (OMS) that automatically creates trading files and transmits them to a broker using the FIX protocol (Financial Information eXchange), who buys the securities using program trade. Program trade is the simultaneous buying/selling of many stocks. These managers also maintain good relationships with the brokers to minimize transaction costs.

Describe full replication method.

Hold all securities in the index. As the manager moves towards more illiquid securities, tracking error gross of transaction costs still decreases but net tracking error can start to go up at one point. In full replication, managers order Market On Close orders to fully match index performance measures.

Stratefied sampling.

Find strata will be mutually exclusive and also exhaustive. Now weight portfolio holdings proportionately to each stratum's weight in the index.

Optimization approach

Minimum portfolio tracking error subject to constraints such as maximum number of names, market capitalization, portfolio volatility.

pros/cons of optimization approach vs stratefied sampling.

Optimization approach has lower tracking error and takes into account asset correlations, but covariance data is computed on historical data, which might change over time.

Excess return vs tracking error

Excess return is Rp-Rb and can be negative or positive. Tracking error is never negative.

sources of tracking error.

management fees, sampling, intraday trading, commissions, cash drag,

During low interest rates, which sector outperforms, financials or utilities?

Utilities/telecom are high dividend payers. They outperform during periods of low rates, compared with financials, who struggle to lend profitably.

rewarded factors vs unrewarded

Some factors (most commonly, size, value, momentum, and quality) have been shown to be positively associated with a long-term return premium and are often referred to as rewarded factors.

What are the issues with the hedged portfolio approach?

It only takes into account the top and bottom quantiles, although performance does not need to be linear across.

Explain factor tilt portfolios and factor mimicking portfolios.

The factor-tilting portfolio tracks a benchmark index closely but also provides exposures to the chosen factor.

The factor mimicking portfolio is the theoretical construct of having positions in every stock and a resulting exposure to only the one factor you’re interested in.

Tactics used by activist strategies include

Seeking board representation and nominations, engaging in proxy contests, proposing restructuring of balance sheet, reducing management compensation, initiate legal proceedings against existing management for breach of fiduciary duty, breaking up a conglomerate, launching media campaign,

How do markets react to activist announcements?

There is appreciation prior to the announcement, an average 2% on the announcement date, and further appreciation post-announcement.

Describe pairs trading in statistical arbs

Start from a moving average (for instance 130 day) of spreads (log of price differentials of a pair). Then establish a band of +2/-2 standard deviations. Whenever spread exceeds this band, take position. Exit when the spread moves back to the moving average.