Portfolio Management in Practice, Volume 1: Investment Management

Cover
Portfolio Management In Practice Volume 1
Title Page
Copyright
Contents
Preface
Acknowledgments
About the CFA Institute Investment Series
Chapter 1: Professionalism in the Investment Industry
Learning Outcomes
1. Introduction
2. Professions
2.1. How Professions Establish Trust
2.2. Professions Are Evolving
3. Professionalism in Investment Management
3.1. Trust in the Investment Industry
3.2. CFA Institute as an Investment Professional Body
4. Expectations of Investment Professionals
5. Framework for Ethical Decision-Making
5.1. Description of the Framework
6. Challenges for Investment Professionals
7. Summary
References
Practice Problems
Chapter 2: Fintech in Investment Management
Learning Outcomes
1. Introduction
2. What is Fintech?
3. Big Data
3.1. Sources of Big Data
3.2. Big Data Challenges
4. Advanced Analytical Tools: Artificial Intelligence and Machine Learning
4.1. Types of Machine Learning
5. Data Science: Extracting Information from Big Data
5.1. Data Processing Methods
5.2. Data Visualization
6. Selected Applications of Fintech to Investment Management
6.1. Text Analytics and Natural Language Processing
6.2. Robo-Advisory Services
6.3. Risk Analysis
6.4. Algorithmic Trading
7. Distributed Ledger Technology
7.1. Permissioned and Permissionless Networks
7.2. Applications of Distributed Ledger Technology to Investment Management
Summary
Practice Problems
Chapter 3: Capital Market Expectations, Part 1: Framework and Macro Considerations
Learning Outcomes
1. Introduction
2. Framework and Challenges
2.1. A Framework for Developing Capital Market Expectations
2.2. Challenges in Forecasting
3. Economic and Market Analysis
3.1. The Role of Economic Analysis
3.2. Analysis of Economic Growth
3.3. Approaches to Economic Forecasting
3.4. Business Cycle Analysis
3.5. Analysis of Monetary and Fiscal Policy
3.6. International Interactions
4. Summary
References
Practice Problems
Chapter 4: Capital Market Expectations, Part 2: Forecasting Asset Class Returns
Learning Outcomes
1. Introduction
2. Overview of Tools and Approaches
2.1. The Nature of the Problem
2.2. Approaches to Forecasting
3. Forecasting Fixed-Income Returns
3.1. Applying DCF to Fixed Income
3.2. The Building Block Approach to Fixed-Income Returns
3.3. Risks in Emerging Market Bonds
4. Forecasting Equity Returns
4.1. Historical Statistics Approach to Equity Returns
4.2. DCF Approach to Equity Returns
4.3. Risk Premium Approaches to Equity Returns
4.4. Risks in Emerging Market Equities
5. Forecasting Real Estate Returns
5.1. Historical Real Estate Returns
5.2. Real Estate Cycles
5.3. Capitalization Rates
5.4. The Risk Premium Perspective on Real Estate Expected Return
5.5. Real Estate in Equilibrium
5.6. Public vs. Private Real Estate
5.7. Long-Term Housing Returns
6. Forecasting Exchange Rates
6.1. Focus on Goods and Services, Trade, and the Current Account
6.2. Focus on Capital Flows
7. Forecasting Volatility
7.1. Estimating a Constant VCV Matrix with Sample Statistics
7.2. VCV Matrices from Multi-Factor Models
7.3. Shrinkage Estimation of VCV Matrices
7.4. Estimating Volatility from Smoothed Returns
7.5. Time-Varying Volatility: ARCH Models
8. Adjusting a Global Portfolio
8.1. Macro-Based Recommendations
8.2. Quantifying the Views
Summary
References
Practice Problems
Chapter 5: Overview of Asset Allocation
Learning Outcomes
1. Introduction
2. Asset Allocation: Importance in Investment Management
3. The Investment Governance Background to Asset Allocation
3.1. Governance Structures
3.2. Articulating Investment Objectives
3.3. Allocation of Rights and Responsibilities
3.4. Investment Policy Statement
3.5. Asset Allocation and Rebalancing Policy
3.6. Reporting Framework
3.7. The Governance Audit
4. The Economic Balance Sheet and Asset Allocation
5. Approaches to Asset Allocation
5.1. Relevant Objectives
5.2. Relevant Risk Concepts
5.3. Modeling Asset Class Risk
6. Strategic Asset Allocation
6.1. Asset Only
6.2. Liability Relative
6.3. Goals Based
7. Implementation Choices
7.1. Passive/Active Management of Asset Class Weights
7.2. Passive/Active Management of Allocations to Asset Classes
7.3. Risk Budgeting Perspectives in Asset Allocation and Implementation
8. Rebalancing: Strategic Considerations
8.1. A Framework for Rebalancing
8.2. Strategic Considerations in Rebalancing
9. Summary
References
Practice Problems
Chapter 6: Principles of Asset Allocation
Learning Outcomes
1. Introduction
2. Developing Asset Only Asset Allocations
2.1. Mean–Variance Optimization: Overview
2.2. Monte Carlo Simulation
2.3. Criticisms of Mean–Variance Optimization
2.4. Addressing the Criticisms of Mean–Variance Optimization
2.5. Allocating to Less Liquid Asset Classes
2.6. Risk Budgeting
2.7. Factor-Based Asset Allocation
3. Developing Liability-Relative Asset Allocations
3.1. Characterizing the Liabilities
3.2. Approaches to Liability-Relative Asset Allocation
3.3. Examining the Robustness of Asset Allocation Alternatives
3.4. Factor Modeling in Liability-Relative Approaches
4. Developing Goals-Based Asset Allocations
4.1. The Goals-Based Asset Allocation Process
4.2. Describing Client Goals
4.3. Constructing Sub-Portfolios
4.4. The Overall Portfolio
4.5. Revisiting the Module Process in Detail
4.6. Periodically Revisiting the Overall Asset Allocation
4.7. Issues Related to Goals-Based Asset Allocation
5. Heuristics and Other Approaches to Asset Allocation
5.1. The “120 minus your age” rule
5.2. The 60/40 stock/bond heuristic
5.3. The endowment model
5.4. Risk parity
5.5. The 1/N rule
6. Portfolio Rebalancing in Practice
7. Conclusions
References
Practice Problems
Chapter 7: Asset Allocation with Real-World Constraints
Learning Outcomes
1. Introduction
2. Constraints in Asset Allocation
2.1. Asset Size
2.2. Liquidity
2.3. Time Horizon
2.4. Regulatory and Other External Constraints
3. Asset Allocation for the Taxable Investor
3.1. After-Tax Portfolio Optimization
3.2. Taxes and Portfolio Rebalancing
3.3. Strategies to Reduce Tax Impact
4. Revising the Strategic Asset Allocation
4.1. Goals
5. Short-Term Shifts in Asset Allocation
5.1. Discretionary TAA
5.2. Systematic TAA
6. Dealing with Behavioral Biases in Asset Allocation
6.1. Loss Aversion
6.2. Illusion of Control
6.3. Mental Accounting
6.4. Representativeness Bias
6.5. Framing Bias
6.6. Availability Bias
7. Summary
References
Practice Problems
Chapter 8: Currency Management: An Introduction
Learning Outcomes
1. Introduction
2. Review of Foreign Exchange Concepts
2.1. Spot Markets
2.2. Forward Markets
2.3. FX Swap Markets
2.4. Currency Options
3. Currency Risk and Portfolio Return and Risk
3.1. Return Decomposition
3.2. Volatility Decomposition
4. Currency Management: Strategic Decisions
4.1. The Investment Policy Statement
4.2. The Portfolio Optimization Problem
4.3. Choice of Currency Exposures
4.4. Locating the Portfolio Along the Currency Risk Spectrum
4.5. Formulating a Client-Appropriate Currency Management Program
5. Currency Management: Tactical Decisions
5.1. Active Currency Management Based on Economic Fundamentals
5.2. Active Currency Management Based on Technical Analysis
5.3. Active Currency Management Based on the Carry Trade
5.4. Active Currency Management Based on Volatility Trading
6. Tools of Currency Management
6.1. Forward Contracts
6.2. Currency Options
6.3. Strategies to Reduce Hedging Costs and Modify a Portfolio’s
Risk Profile
6.4. Hedging Multiple Foreign Currencies
6.5. Basic Intuitions for Using Currency Management Tools
7. Currency Management for Emerging Market Currencies
7.1. Special Considerations in Managing Emerging Market Currency Exposures
7.2. Non-Deliverable Forwards
8. Summary
References
Practice Problems
Chapter 9: Overview of Fixed-Income Portfolio Management
Learning Outcomes
1. Introduction
2. Roles of Fixed-Income Securities in Portfolios
2.1. Diversification Benefits
2.2. Benefits of Regular Cash Flows
2.3. Inflation Hedging Potential
3. Fixed-Income Mandates
3.1. Liability-Based Mandates
3.2. Total Return Mandates
4. Bond Market Liquidity
4.1. Liquidity among Bond Market Sub-Sectors
4.2. The Effects of Liquidity on Fixed-Income Portfolio Management
5. A Model for Fixed-Income Returns
5.1. Decomposing Expected Returns
5.2. Estimation of the Inputs
5.3. Limitations of the Expected Return Decomposition
6. Leverage
6.1. Using Leverage
6.2. Methods for Leveraging Fixed-Income Portfolios
6.3. Risks of Leverage
7. Fixed-Income Portfolio Taxation
7.1. Principles of Fixed-Income Taxation
7.2. Investment Vehicles and Taxes
8. Summary
References
Practice Problems
Chapter 10: Liability-Driven and Index-Based Strategies
Learning Outcomes
1. Introduction
2. Liability-Driven Investing
3. Interest Rate Immunization—Managing the Interest Rate Risk of a Single Liability
4. Interest Rate Immunization—Managing the Interest Rate Risk of Multiple Liabilities
4.1. Cash Flow Matching
4.2. Duration Matching
4.3. Derivatives Overlay
4.4. Contingent Immunization
5. Liability-Driven Investing—An Example of a Defined Benefit Pension Plan
6. Risks in Liability-Driven Investing
7. Bond Indexes and the Challenges of Matching a Fixed-Income Portfolio to an Index
8. Alternative Methods for Establishing Passive Bond Market Exposure
9. Benchmark Selection
10. Laddered Bond Portfolios
11. Summary
References
Practice Problems
Chapter 11: Overview of Equity Portfolio Management
Learning Outcomes
1. Introduction
2. The Roles of Equities in a Portfolio
2.1. Capital Appreciation
2.2. Dividend Income
2.3. Diversification with Other Asset Classes
2.4. Hedge Against Inflation
2.5. Client Considerations for Equities in a Portfolio
3. Equity Investment Universe
3.1. Segmentation by Size and Style
3.2. Segmentation by Geography
3.3. Segmentation by Economic Activity
3.4. Segmentation of Equity Indexes and Benchmarks
4. Income and Costs in an Equity Portfolio
4.1. Dividend Income
4.2. Securities Lending Income
4.3. Ancillary Investment Strategies
4.4. Management Fees
4.5. Performance Fees
4.6. Administration Fees
4.7. Marketing and Distribution Costs
4.8. Trading Costs
4.9. Investment Approaches and Effects on Costs
5. Shareholder Engagement
5.1. Benefits of Shareholder Engagement
5.2. Disadvantages of Shareholder Engagement
5.3. The Role of an Equity Manager in Shareholder Engagement
6. Equity Investment across the Passive–Active Spectrum
6.1. Confidence to Outperform
6.2. Client Preference
6.3. Suitable Benchmark
6.4. Client-Specific Mandates
6.5. Risks/Costs of Active Management
6.6. Taxes
Summary
References
Practice Problems
Chapter 12: Passive Equity Investing
Learning Outcomes
1. Introduction
2. Choosing a Benchmark
2.1. Indexes as a Basis for Investment
2.2. Considerations When Choosing a Benchmark Index
2.3. Index Construction Methodologies
2.4. Factor-Based Strategies
3. Approaches to Passive Equity Investing
3.1. Pooled Investments
3.2. Derivatives-Based Approaches
3.3. Separately Managed Equity Index-Based Portfolios
4. Portfolio Construction
4.1. Full Replication
4.2. Stratified Sampling
4.3. Optimization
4.4. Blended Approach
5. Tracking Error Management
5.1. Tracking Error and Excess Return
5.2. Potential Causes of Tracking Error and Excess Return
5.3. Controlling Tracking Error
6. Sources of Return and Risk in Passive Equity Portfolios
6.1. Attribution Analysis
6.2. Securities Lending
6.3. Investor Activism and Engagement by Passive Managers
Summary
References
Practice Problems
Chapter 13: Active Equity Investing: Strategies
Learning Outcomes
1. Introduction
2. Approaches to Active Management
2.1. Differences in the Nature of the Information Used
2.2. Differences in the Focus of the Analysis
2.3. Difference in Orientation to the Data: Forecasting the Future vs. Analyzing the Past
2.4. Differences in Portfolio Construction: Judgment vs. Optimization
3. Types of Active Management Strategies
3.1. Bottom-Up Strategies
3.2. Top-Down Strategies
3.3. Factor-Based Strategies
3.4. Activist Strategies
3.5. Other Strategies
4. Creating a Fundamental Active Investment Strategy
4.1. The Fundamental Active Investment Process
4.2. Pitfalls in Fundamental Investing
5. Creating a Quantitative Active Investment Strategy
5.1. Creating a Quantitative Investment Process
5.2. Pitfalls in Quantitative Investment Processes
6. Equity Investment Style Classification
6.1. Different Approaches to Style Classification
6.2. Strengths and Limitations of Style Analysis
7. Summary
References
Practice Problems
Chapter 14: Hedge Fund Strategies
Learning Outcomes
1. Introduction
2. Classification of Hedge Funds and Strategies
3. Equity Strategies
3.1. Long/Short Equity
3.2. Dedicated Short Selling and Short-Biased
3.3. Equity Market Neutral
4. Event-Driven Strategies
4.1. Merger Arbitrage
4.2. Distressed Securities
5. Relative Value Strategies
5.1. Fixed-Income Arbitrage
5.2. Convertible Bond Arbitrage
6. Opportunistic Strategies
6.1. Global Macro Strategies
6.2. Managed Futures
7. Specialist Strategies
7.1. Volatility Trading
7.2. Reinsurance/Life Settlements
8. Multi-Manager Strategies
8.1. Fund-of-Funds
8.2. Multi-Strategy Hedge Funds
9. Analysis of Hedge Fund Strategies
9.1. Conditional Factor Risk Model
9.2. Evaluating Equity Hedge Fund Strategies
9.3. Evaluating Multi-Manager Hedge Fund Strategies
10. Portfolio Contribution of Hedge Fund Strategies
10.1. Performance Contribution to a 60/40 Portfolio
10.2. Risk Metrics
11. Summary
References
Practice Problems
Chapter 15: Overview of Private Wealth Management
Learning Outcomes
1. Introduction
2. Private Clients versus Institutional Clients
2.1. Investment Objectives
2.2. Constraints
2.3. Other Distinctions
3. Understanding Private Clients
3.1. Information Needed in Advising Private Clients
3.2. Client Goals
3.3. Private Client Risk Tolerance
3.4. Technical and Soft Skills for Wealth Managers
4. Investment Planning
4.1. Capital Sufficiency Analysis
4.2. Retirement Planning
5. Investment Policy Statement
5.1. Parts of the Investment Policy Statement
5.2. Sample Investment Policy Statement for a Private Client
6. Portfolio Construction and Monitoring
6.1. Portfolio Allocation and Investments for Private Wealth Clients
6.2. Portfolio Reporting and Review
6.3. Evaluating the Success of an Investment Program
7. Ethical and Compliance Considerations in Private Wealth Management
7.1. Ethical Considerations
7.2. Compliance Considerations
8. Private Client Segments
8.1. Mass Affluent Segment
8.2. High-Net-Worth Segment
8.3. Ultra-High-Net-Worth Segment
8.4. Robo-Advisors
Summary
References
Practice Problems
Chapter 16: Topics in Private Wealth Management
Learning Outcomes
1. Introduction
2. General Principles of taxation
2.1. Taxation of the Components of Return
2.2. The Tax Status of the Account
2.3. The Jurisdiction That Applies to the Investor
3. Measuring Tax Efficiency with After-Tax Returns
3.1. Tax Efficiency of Various Asset Classes and Investment Strategies
3.2. Calculating After-Tax Returns
4. Analyzing the Impact of Taxes IN taxable, Tax-Exempt, and Tax-Deferred Accounts
4.1. Capital Accumulation in Taxable, Tax-Deferred, and Tax-Exempt Accounts
4.2. Asset Location
4.3. Decumulation Strategies
4.4. Tax Considerations in Charitable Giving
5. Tax Management Strategies
5.1. Basic Portfolio Tax Management Strategies
5.2. Application of Tax Management Strategies
6. Managing Concentrated Positions
6.1. Risk and Tax Considerations in Managing Concentrated Single-Asset Positions
6.2. Strategies for Managing Concentrated Positions in Public Equities
6.3. Strategies for Managing Concentrated Positions in Privately Owned Businesses
6.4. Strategies for Managing Concentrated Positions in Real Estate
7. Directing and transferring wealth
7.1. Objectives of Gift and Estate Planning
7.2. Gift and Estate Planning Strategies
7.3. Managing Wealth across Generations
8. Summary
References
Practice Problems
Chapter 17: Portfolio Management for Institutional Investors
Learning Outcomes
1. Introduction
2. Institutional Investors: Common Characteristics
2.1. Scale
2.2. Long-Term Investment Horizon
2.3. Regulatory Frameworks
2.4. Governance Framework
2.5. Principal–Agent Issues
3. Overview of Investment Policy
4. Pension Funds
4.1. Stakeholders
4.2. Liabilities and Investment Horizon
4.3. Liquidity Needs
4.4. External Constraints Affecting Investment
4.5. Risk Considerations of Private Defined Benefit Pension Plans
4.6. Investment Objectives
4.7. Asset Allocation by Pension Plans
5. Sovereign Wealth Funds
5.1. Stakeholders
5.2. Liabilities and Investment Horizons
5.3. Liquidity Needs
5.4. External Constraints Affecting Investment
5.5. Investment Objectives
5.6. Asset Allocation by Sovereign Wealth Funds
6. University Endowments and Private Foundations
6.1. University Endowments—Stakeholders
6.2. University Endowments—Liabilities and Investment Horizon
6.3. University Endowments—Liquidity Needs
6.4. Private Foundations—Stakeholders
6.5. Private Foundations—Liabilities and Investment Horizon
6.6. Private Foundations—Liquidity Needs
6.7. External Constraints Affecting Investment
6.8. Investment Objectives
6.9. Asset Allocation
7. Banks and Insurers
7.1. Banks—Stakeholders
7.2. Banks—Liabilities and Investment Horizon
7.3. Banks—Liquidity Needs
7.4. Insurers—Stakeholders
7.5. Insurers—Liabilities and Investment Horizon
7.6. Insurers—Liquidity Needs
7.7. External Constraints Affecting Investment
7.8. Investment Objectives
7.9. Banks and Insurers—Balance Sheet Management and Investment Considerations
Summary
References
Practice Problems
Chapter 18: Trade Strategy and Execution
Learning Outcomes
1. Introduction
2. Motivations to Trade
2.1. Profit Seeking
2.2. Risk Management/Hedging Needs
2.3. Cash Flow Needs
2.4. Corporate Actions/Index Reconstitutions/Margin Calls
3. Trading Strategies and Strategy Selection
3.1. Trade Strategy Inputs
3.2. Reference Prices
3.3. Trade Strategies
4. Trade Execution (Strategy Implementation)
4.1. Trade Implementation Choices
4.2. Algorithmic Trading
4.3. Comparison of Markets
5. Trade Evaluation
5.1. Trade Cost Measurement
5.2. Evaluating Trade Execution
6. Trade Governance
6.1. Meaning of Best Order Execution within the Relevant Regulatory Framework
6.2. Factors Used to Determine the Optimal Order Execution Approach
6.3. List of Eligible Brokers and Execution Venues
6.4. Process Used to Monitor Execution Arrangements
7. Summary
Practice Problems
Chapter 19: Portfolio Performance Evaluation
Learning Outcomes
1. Introduction
2. The Components of Performance Evaluation
3. Performance Attribution
3.1. Approaches to Return Attribution
3.2. Risk Attribution
3.3. Return Attribution Analysis at Multiple Levels
4. Benchmarking Investments and Managers
4.1. Asset-Based Benchmarks
4.2. Properties of a Valid Benchmark
4.3. Evaluating Benchmark Quality: Analysis Based on a Decomposition of Portfolio Holdings and Returns
4.4. Benchmarking Alternative Investments
4.5. Importance of Choosing the Correct Benchmark
5. Performance Appraisal
5.1. Distinguishing Investment Skill from Luck
5.2. Appraisal Measures
5.3. Evaluation of Investment Manager Skill
Summary
References
Practice Problems
Chapter 20: Investment Manager Selection
Learning Outcomes
1. Introduction
2. A Framework for Investment Manager Search and Selection
2.1. Defining the Manager Universe
2.2. Type I and Type II Errors in Manager Selection
3. Quantitative Elements of Manager Search and Selection
3.1. Style Analysis
3.2. Capture Ratios and Drawdowns in Manager Evaluation
4. Qualitative Elements of Manager Due Diligence
4.1. Investment Philosophy
4.2. Investment Personnel
4.3. Investment Decision-Making Process
4.4. Operational Due Diligence
5. Summary
References
Practice Problems
Glossary
About the Authors
About the CFA Program
Index
EULA