2015, Study Session # 12, Reading # 41

PORTFOLIO MANAGEMENT AN OVERVIEW

42.a
MPT
NAV
FI
SD

=
=
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Modern Portfolio Theory

Net Asset Value
Fixed Income
Standard Deviation

Portfolio perspective evaluates individual investments in a portfolio context

(risk & return contribution).

Diversification reduces portfolio risk without necessarily reducing expected
return according to MPT.

MPT results in equilibrium expected return for securities & portfolios given
market risk.

Diversification ratio = S.D of equally weighted portfolio / S.D of a single security
from portfolio.

Computer based optimization calculates portfolio weights that produce lowest
portfolio risk.

During financial crisis correlations tend to
, diversification benefit.

41.b

Individual Investor
Invest for variety of reasons (purchase a house, for retirement etc).
Defined Contribution Pension Plan

Individual makes investment decisions &
takes investment risk.

No guarantee of specific future pension
payments.
Institutional Investors

Endowment

Fund that provide
ongoing financial
support for a specific
purpose.

Long horizon with high
risk tolerance little
liquidity needs.

Foundation

Banks

Defined Benefit

Fund for charitable purpose

or research related to a
particular disease.

A common objective is to
maintain real portfolio
value while generating
income to meet funding
needs

Long horizon, low liquidity
needs & high risk tolerance.

Objective is to earn
more on investments
than pays to depositors.

Investments need to be
of low risk and should be
relatively liquid.

Obligation to provide
benefits to retirees.

Long time horizon &
select investments that
match pension liabilities.

Insurance Companies

Invest premiums for
funding customer
claims.

Life insurance longtime horizon.

Property & casualty
insurance shorter
horizon than life
insurance.

Investment Companies

Manage pooled funds of
many investors.

Mutual funds manage
pooled funds in
particular style (index,
growth etc).

Sovereign wealth fund

Pools of assets owned
by a govt.

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2015, Study Session # 12, Reading # 41

41.c

Steps in Portfolio Management Process

Planning

Execution

Analysis of objectives & constraints &

IPS development.

Benchmark is selected for
performance measurement.

IPS should be updated regularly or
when circumstances dictate
otherwise.

Analysis of risk & return of various

asset classes.

Top-down analysis examines
current economic conditions &
constructs a well diversified portfolio.

Bottom up analysis identify most
attractive securities.

41.d

Feedback

Monitor changes & rebalance

portfolios periodically.

Measure portfolio performance &
compare it with benchmark

Mutual Funds

Open-End-Fund

Closed-End-Fund

Buy & redeem share at NAV.

Fund charge ongoing management
fee.

No load funds no additional fee.

Load funds charge upfront,
redemption or both fees.

Each investor owns a portion of overall

portfolio.

NAV =

 


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Dont take new investments into fund

or redeem investor shares (shares
trade like equity)

Charge on-going management fees.

Types of Mutual Funds

Money Market Funds

Bond Mutual Funds

Invest in short term debt securities

with low risk of value change.

Funds are differentiated by maturities
& types of securities.

Invest in FI securities.

Differentiated by maturities, credit
ratings, issuers & types.

Other Forms of Pooled Investments

ETFs

Purchase and sale of investments
between investors (similar to closedend funds).

Most try to match a particular index
(passively managed).

In-kind creation and redemption
provision process keeps ETF price
close to NAV.

Can be shorted or margined.

Less capital gain liability as compared
to open end fund (in kind
redemption).

Stock Mutual Funds

Index Funds
Passive
investments to
match the
performance of a
particular index.

Separately Managed Accounts

Portfolio owned by a single
investor.

Select securities with

object to beat
benchmark.

Higher turnover,

management fee,
tax
liabilities.

Hedge Funds

Not regulated to the extent that
mutual funds are.

Qualified investors (normally rich
individuals).

Buyout Funds

Typically buy public companies &
take them private.

Use of significant leverage.

Sell restructured firm in public
offering or to another company
after a period of time (3 to 5 years).

Actively Managed Funds

Venture Capital Funds

Invest in companies in start up
phase with intention to sell in IPO
or to an established firm after
growing the company.

Expertise in industries in which
they focus.

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2015, Study Session # 12, Reading # 41

41.d

Hedge Fund

Long / Short Funds

Buy undervalued securities.

Sell overvalued Securities.

F.I Arbitrage Funds

Take positions in debt securities to
exploit mispricing while minimizing
interest rate risk.

Equity Market-Neutral Fund

Event-Driven Funds

Value of long positions will exactly

offset the value of short positions.

Profitable as long as longs
outperform shorts.

Long (short) bias larger long
(short) position relative to short
(long) positions.

Invest in response to corporate events

(e.g. mergers & acquisitions).

Convertible Bond Arbitrage Funds

Global Macro Funds

Take positions in convertible bonds

and related equity to profit from
relative mispricing.

Speculate on exchange rates &

interest rates globally & use
derivatives & leverage.

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