CFA Volume 6 Module 1

Portfolio management, Ethics and professional standards

Portfolio Approach

evaluating securities based on their contribution to the whole portfolio

401k

a tax deferred retirement account. Think Enron scandal.

Enron scandal

Demonstrated the importance of portfolio diversification.

Standard deviation

expected return/ volatility.

Diversification ratio

standard deviation of equally weighted portfolio/ standard deviation single selected security

MPT

Proposed by Harry Markowitz (1952) . Suggests investors should not only portfolios, but focus on how each security behaves in relation to one another

Capital Asset Pricing Model (CAPM)

how much extra return an asset offers (risk premium) for the risk taken in the portfolio.

When does the diversification benefit fail?

When the pattern of co-movements change, such as in 2008).

Proposed the CAPM

William Sharpe, John Lintner ans Jack Treynor.

Endowment

Pool of money that is donated to an institution (universities etc) and invested to generate income

3 steps in portfolio management

1. Planning step. 2. The execution step. 3. The feedback step.

investment policy statement (IPS)

A planning document that describes the client's needs. Should be revised and updated regularly.

What types of assets should be considered in the execution step (asset allocation)?

fixed-income securities, equities, cash, sub-assets, real estate, commodities, private equity, hedge fund etc.

Top- Down analysis.

Macro economic conditions to individual companies.

Bottom- down analysis.

Focuses on company-specific circumstances.

Feedback step

Portfolio monitoring and rebalancing. Performance measurement and reporting. Reassessing client's needs.

Two types of clients

Individual investors and institutional investors.

Defined contribution pension plans (DC)

Retirement plans in the employee’s name. Usually funded by both the employee and the employer.

what kinds of institutions are in the institutional investor bracket.

Endowments, charities, defined benefit pension plans, banks, insurance companies, investment companies and sovereign wealth funds. D

Defined benefit pension plan. (DB)

Company-sponsored plans that offer employees a predefined benefit on retirement. Employers are the ones responsible for the contributions. (riskier and more expensive for the company).

Australia and US

Weighed more towards DC plans.

Netherlands, UK, Canada and Japan

Weighed more towards DB plans.

Smoothing rule

Spending rule used by endowments and foundations to keep their spending predictable and protect their portfolio from large fluctuations.

Banks

Short-term. They invest in fixed- income assets and need to have liquidity to meet withdrawals. Risk tolerance: low.

Endowments/ foundations

Long-term. Used to meet spending commitments. Risk tolerance: typically high.

Insurance companies.

Long-term for life insurance. Short term for property insurance. Used to cover claims. Risk tolerance” typically low.

Specialist asset managers

Focus on a specialized asset class/ management style.

Full service managers.

offer a wide variety of services and asset classes.

Multi-boutique

A holding company that owns several asset management firms that offer different specialized strategies.

Active managers

try to surpass a benchmark. (Such as the S&P 500)

Passive managers

try to match a benchmark. (Such as the S&P 500)

Smart Beta

Other strategies offered by firms beyond traditional market cap weighed exposures.

Traditional asset managers

Managers that focus mainly on long-only equities, fixed-income assets, and multi-asset strategies. Generate most of their income in management fees.

Alternative asset managers

Managers that focus on hedge funds, private equity and venture capital while generating both performance and fee income.

Liquid alternatives

Retail versions of alternative products that offer no fees, less leverage and are typically more liquid. (Think mutual funds).

Ex ante alpha

The expected extra return from a benchmark. Example- S&P expected return is 5% and my strategy is 8%, ex ante alpha is 3%.

Robo-advisors

Technology solutions that use automation and investment algorithms to provide wealth management services.

Types of pooled products. 

separately managed accounts, ETFs, hedge funds, private equity/ venture capital funds.

Mutual funds

Third party investment portfolio management.

open-end funds.

Mutual funds in which new investment money is accepted and shares at NAV are issued.

closed-end funds.

Mutual funds in which new investment is not accepted, and new investors need to buy existing shares from holders.

Money Market funds

mutual funds that invest in short-term money market instruments such as treasury bills, commercial paper or certificates of deposit.

Taxable Money Market fund

Invest high quality short term federal and corporate debt (bonds).

Tax free Money Market Fund

Investing short term state or local government debt (bonds).

Bond mutual funds.

Similar to Money Market funds but they are long term. Net Asset Value (NAV)= sum of the value of holdings/ number of shares. 

Types of bond funds.

Global, Government, Corporate, High Yield, inflation protected, National Tax-free bonds.

Stock mutual funds

Largest types of funds, based on market value of assets under management.

Hybrid/ balanced funds.

Funds that invest in both stocks and bonds. Most common in Europe but present in the US.