Advanced Portfolio Management KASNEB Notes

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CIFA ADVANCED LEVEL

COURSE OUTLINE

GENERAL OBJECTIVE

This paper is intended to equip the candidate with the knowledge, skills and attitudes that will enable him/her to apply advanced portfolio management skills.

LEARNING OUTCOMES

A candidate who passes this paper should be able to:

  • Identify the different types of individual and institutional investors
  • Allocate different asset classes when constructing a portfolio
  • Analyse different strategies used to manage a portfolio of different asset classes
  • Apply trade execution decisions and techniques in portfolio management
  • Undertake portfolio monitoring and rebalancing processes
  • Evaluate the performance of a portfolio.

CONTENT

Managing individual portfolios and institutional investors:

Individual investors:

  • Overview of investor characteristics: situational profiling (source of wealth, measure of wealth, stage of life); psychological profiling (traditional finance, behavioural finance, personality typing)
  • Investment policy statement for an individual investor
  • Strategic asset allocation for an individual investor: Monte Carlo simulation in personal retirement planning

Institutional investors:

  • Overview of pension funds: defined-benefit and defined-contribution plans; pension fund risk tolerance; defined benefit and defined contribution investment policy statement; risk management considerations; hybrid pension plans; employee share ownership plans
  • Other institutional investors: Foundations, endowments, Insurance industry (life and non-life insurance companies), banks, investment intermediaries and other institutional investors; their background and investment setting

Asset allocation

  • Overview of asset allocation: role of asset allocation in portfolio management; strategic versus tactical asset allocation; importance of asset allocation in portfolio performance; steps involved in establishing an appropriate asset allocation
  • Asset allocation and investors and return objectives: dynamic versus static asset allocation; factors affecting asset allocation policy(loss aversion; mental accounting; fear of regret); return and risk objectives in relation to asset allocation
  • Selection     of asset classes: criteria for specifying asset classes; inclusion of international assets (developed and emerging markets)
  • Optimisation approaches to asset allocation: mean-variance approach (Its application when adding an asset class in an existing portfolio); resampled efficient frontier; experience based approaches; asset only, asset/liability management (ALM); ); Black– Letterman approach: Monte-Carlo Simulation
  • Nondomestic equities and bonds: Their associated risks, costs and opportunities
  • Conditional return correlations: their importance when evaluating the diversification effects of nondomestic investments
  • Integrating a segmented market with a global market: expected effects on share prices expected returns, and return volatilities
  • Formulation and justification of minimum-variance frontier given investment policy statement and capital market expectations

Fixed income portfolio management

  • Use of liability as a benchmark and use of bond index as a benchmark with respect to investment objectives
  • Managing funds against a bond market: classification of strategies (pure bond indexing/full replication approach, enhanced indexing and active investing, full- blown); selection of a benchmark bond index and factors to consider(market value risk, income risk, liability framework risk); use of bond market indices
  • Techniques used to align the risk exposures of the portfolio with those of the benchmark bond index: duration matching technique, key rate durations technique
  • Assessment of the risk and return characteristics of a proposed trade: total return analysis, scenario analysis
  • Bond immunisation strategy: its formulation and evaluation under various interest rate scenarios
  • Spread duration and its importance
  • Extension of classical immunisation theory: introduction of contingent immunisation
  • Risks associated with managing a portfolio against a liability structure: interest rate risk, contingent claim risk, cap risk
  • Immunisation strategies for single liability, multiple liabilities and general cash flows: their advantages and disadvantages
  • Immunised portfolios: risk immunisation and return maximisation
  • Cash flow matching: its use in funding a fixed set of future liabilities; its advantages and disadvantages

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Relative value methodologies for global credit bond portfolio management

  • Classic relative value analysis based on top down and bottom up approaches to credit bond portfolio management
  • Cyclical supply and demand changes: their implications in the primary bond markets; impact of secular changes in the markets dominant structures
  • Investors  short  term  and  long  term  liquidity  needs:  their  influence    on portfolio management decisions
  • Common rationale for secondary market trading
  • Corporate bond portfolio strategies

International and emerging market fixed-income portfolio management strategies

  • Effect of leverage on portfolio duration and investment returns
  • Use of repurchase agreements (repos) to finance bond purchases: Factors affecting the repo rate
  • Measures of fixed income portfolio risk: standard deviation, target semi variance, shortfall risk and value at risk (VaR)
  • Use of futures instead of cash market instruments to alter portfolio risk
  • Formulation and evaluation of an immunisation strategy based on interest rates
  • Use of interest rate swaps and options to alter portfolio cash flows and exposure to interest rate risk; use of credit derivative instruments to address default risk, credit spread risk and downgrade risk in the context of fixed income portfolio
  • Potential sources of excess return for an international bond portfolio
  • Effect of change in value for a foreign bond when domestic interest rates change, and the bond’s contribution to duration in domestic portfolio, given the duration of the foreign bond and the country beta
  • Hedging currency risk in international bond markets; break even spread analysis in seeking yield advantages across international bond market; investing in emerging market debt:
  • Criteria for selecting a fixed income manager

Equity portfolio management

  • Role of the equity in the overall portfolio
  • Equity investment approaches: passive approach; active approach; semi-active (enhanced-index ) approach; their relevance with respect to expected active return and tracking risk
  • Weighting schemes used in the construction of major equity market indices and the biases associated with each
  • Passive equity investing: alternative methods for establishing passive  exposure to an equity market; indexed separate or pooled accounts, index mutual funds, exchange-traded funds, equity index futuresand equity total return swaps
  • Approaches to constructing an indexed portfolio: full replication, stratified samplingand optimisation
  • Active equity investing: equity investment–styles classifications and risks associated with each; techniques for identifying investment styles; equity style indices; equity style box analysis and style drift; long–short and long-only investment strategies; ‘equitised’ market-neutral and short-extension portfolios; sell disciplines/trading of active investors
  • Semi-active equity investing (enhanced-index): derivatives-based and stock-based enhanced indexing strategies
  • Managing a portfolio of managers: core-satellite approach to portfolio construction; effect of adding a completeness fund to control overall risk exposures
  • Components of total active return (“true” active return and “misfit” active return) and their associated risk measures; alpha and beta separation as an approach to active management;
  • Identifying, selecting, and contracting with equity managers
  • Structuring equity research and security selection: top-down and bottom-up approaches to equity research

Alternative investments portfolio management

  • Introduction to alternative investments portfolio management
  • Selection of active managers of alternative investment scheme
  • Alternative investment benchmarks: construction and interpretation; benchmark bias
  • Return enhancement and risk diversification effects of adding an alternative investment to a reference portfolio(for instance a portfolio of bonds and equity only)
  • Venture capital: major issuers and suppliers; purpose of venture capital; buyout funds; use of convertible preferred stock in direct venture capital investment
  • Private equity fund: typical structure and timelines; formulating private equity investment strategy
  • Commodity investments: direct and indirect commodity investment; components of return for commodity futures contracts; role of commodities in a portfolio
  • Hedge funds: typical structure; high water- mark provisions; fund-of-funds; performance and evaluation
  • Managed futures: trading strategies; role in a portfolio
  • Distressed securities: risks associated with investing in distressed securities including event risk, market liquidity risk, ‘J-factor’ risk

Currency portfolio management

  • Effects of currency movements on portfolio risk and return
  • Strategic choices in portfolio management
  • Active currency trading strategies based on economic fundamentals, technical analysis, curry trade and volatility trading
  • Adjusting the hedge ratio using forward contracts and foreign exchange (FX) swaps
  • Trading strategies used to reduce hedging costs and modify the risk return characteristics of a foreign currency portfolio
  • Portfolios exposed to multiple foreign currencies: use of cross-hedges ratio, macro- hedges ratio, minimum-variance-hedge ratio
  • Challenges for managing emerging market currency exposures

Execution of portfolio decisions

  • The context of trading: market microstructure: order types and their price and execution uncertainties, their effective spread and their quoted bid ask spread ;  types of markets and their quality; roles of brokers and dealers
  • Costs of trading: transaction costs components (explicit and implicit costs); implementation shortfall  and volume weighted average price (VWAP) as measures of transaction costs; use of econometric methods/models in pre-trade analysis to estimate implicit transaction costs
  • Major types of traders: their motivation to trade, time versus price preferences and preferred order types; major trading tactics ;algorithmic trading strategies and determining factors including order size, average daily trading volume, bid–ask spread and the urgency of the order
  • Trade execution decision and tactics: meaning and criteria of best execution; firm’s investment and trading procedures, including processes, disclosures and record keeping with respect to best execution
  • Role of ethics in trading

Portfolio monitoring and rebalancing

  • Monitoring : fiduciary’s responsibilities in monitoring an investment portfolio; monitoring of investor circumstances, market/economic conditions and portfolio holdings; revisions to an investor’s investment policy statement and strategic asset allocation, given a change in investor circumstances
  • Rebalancing: benefits and costs of rebalancing a portfolio to the investor’s strategic asset allocation; calendar rebalancing; percentage-of-portfolio rebalancing; optimal corridor width of an asset class; target portfolio rebalancing versus allowed range portfolio rebalancing; rebalancing strategies (linear, concave, and convex rebalancing strategies); constant mix, buy-and-hold, and constant proportion  portfolio insurance (CPPI) rebalancing strategies

Evaluating portfolio performance

  • Importance of performance evaluation from the perspective of fund sponsors and the perspective of investment managers
  • Components of performance evaluation: performance measurement, performance attribution and performance appraisal
  • Performance measurement: total, time-weighted, money-weighted rates of return, linked internal rate of return and annualized return
  • Benchmarks: concept of a benchmark; properties of a valid benchmark; types; steps involved in constructing a custom security-based benchmark; validity of using manager universes as benchmarks; tests of benchmark quality; hedge funds and hedge fund benchmarks
  • Performance attribution: inputs for micro and macro attribution; use of macro and micro performance attribution methodologies to identify the sources of investment performance; use of fundamental factor models in micro performance attribution
  • Performance appraisal: risk-adjusted performance measures, including (in their ex post forms) alpha, information ratio, Treynor measure, Sharpe ratio and Modigliani- Modiglian measure(M2 ) ;incorporation of portfolio’s alpha and beta into the information ratio, Treynor measure, and Sharpe ratio; use of performance quality control charts in performance appraisal
  • Practice of performance evaluation: noisiness of performance data; manager continuation policy decisions

Emerging issues and trends

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