1 / 69

Chapter 25 Contemporary Issues in Portfolio Management

Chapter 25 Contemporary Issues in Portfolio Management. Life is my college; may I graduate well and earn some honors. - Louisa May Alcott. Outline. Introduction Tactical asset allocation Stock lending Program trading Role of derivative assets The chartered financial analyst program

justin
Download Presentation

Chapter 25 Contemporary Issues in Portfolio Management

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Chapter 25Contemporary Issues in Portfolio Management

  2. Life is my college; may I graduate well and earn some honors. - Louisa May Alcott

  3. Outline • Introduction • Tactical asset allocation • Stock lending • Program trading • Role of derivative assets • The chartered financial analyst program • Regulation Fair Disclosure • Security analyst independence

  4. Introduction • Some emerging areas are controversial: • Tactical asset allocation contradicts the EMH • Stock lending and program trading have image problems • Derivatives are not permitted in some portfolios

  5. Tactical Asset Allocation • What is tactical asset allocation? • How TAA can benefit a portfolio • Designing a TAA program • Caveats regarding TAA performance

  6. What Is Tactical Asset Allocation? • Definition • Intuitive versus quantitative techniques • Overview of the technique • Policy decisions • Strategy

  7. Definition • Tactical asset allocation (TAA) managers: • Seek to improve the performance of their funds • By shifting the relative proportion of their investments into and out of asset classes • As the relative prospects of those asset classes change • For example, shift to stocks if stocks are expected to outperform bonds

  8. Definition (cont’d) • TAA attempts to take advantage of short-term deviations from long-term trends • The most difficult part of TAA is asset class appraisal • The process of determining the relative merits of the various asset classes given current economic conditions

  9. Intuitive Versus Quantitative Techniques • In the intuitive approach, decisions are based on personal opinion and gut feeling • Suffers from hindsight bias • Portfolio managers remember the times they were correct

  10. Intuitive Versus Quantitative Techniques (cont’d) • In the quantitative approach, managers use an analytical assessment and a system for implementing precise portfolio changes • E.g., use the gap between the S&P 500 dividend yield and the average yield on AAA corporate bonds

  11. Overview of the Technique

  12. Policy Decisions • Policy decisions involve: • Deciding to use a TAA program in the first place • Establishing the extent to which the program will be employed • Determining the number of asset classes to employ

  13. Strategy • There are three alternative strategic functions: • Static strategy maintains a static portfolio mix • Reactive strategy involves decisions based on events that have already occurred • Anticipatory strategy involves shifting funds before the markets move

  14. How TAA Can Benefit A Portfolio • The goal of an anticipatory strategy is to outperform the portfolio without TAA • The potential gains to a clairvoyant manager from TAA are enormous (see next slide) • The portfolio manager must assess return within a risk/return framework

  15. How TAA Can Benefit A Portfolio (cont’d)

  16. Designing A TAA Program • Before implementing a TAA program, a fund manager must establish: • The normal mix • The benchmark proportion each asset class constitutes in the portfolio • The mix (exposure) range • Specifies how much the current mix can deviate from the normal mix

  17. Designing A TAA Program (cont’d) • Before implementing a TAA program, a fund manager must establish (cont’d): • The swing component • The percentage of the total portfolio whose composition by asset class may change • The key element of TAA is properly investing the swing component

  18. Caveats Regarding TAA Performance • Efficient market implications • Impact of transaction costs

  19. Efficient Market Implications • TAA program implicitly assume it is possible to outperform a buy-and-hold strategy by shifting asset classes • Inconsistent with the efficient market hypothesis • Some fund managers have good records with TAA programs • Might be skill or luck

  20. Impact of Transaction Costs • The portfolio incurs trading fees each time a trade occurs • If the marginal gains from TAA switching do not exceed transaction costs, the program is not effective

  21. Stock Lending • Definition • Mechanics of a short sale • How a stock lending transaction works • Stock lending’s lucrative nature • Regulatory concerns • Long/short portfolios • Certificateless trading

  22. Definition • Stock lending: • Is the practice by which one institution loans stock to another institution • Is often used to support short-selling by customers of the second institution • Can earn substantial income with very little risk

  23. Definition (cont’d) • Stock lending is similar to a repurchase agreement: • The institution wanting to borrow stock • Puts up collateral (about 102 percent of the securities lent) • Agrees to return the securities at a later date • The lender can earn interest on the cash collateral

  24. Mechanics of A Short Sale • A short sale: • Involves borrowing securities from someone • Selling the securities to another market participant • Eventually purchasing shares from another market participant and • Returning the substitute shares to the original lender

  25. Mechanics of A Short Sale (cont’d) • A short sale is normally motivated by a bearish sentiment • The actual lender in a short sale is normally an unknowing participant • A hypothecation agreement gives the broker the right to lend shares to someone else • The investor can still trade the shares and continues to earn dividends

  26. Mechanics of A Short Sale (cont’d) • The short seller: • Has an obligation to return what was borrowed at some point in the future • Must pay dividends to the lender • Eventually covers short by repurchasing shares to replace the shares borrowed earlier • If the purchase price is below the selling price, the short seller makes a profit

  27. How A Stock Lending Transaction Works • If the customer wants to short sell: • The brokerage firm first checks if other customers have the stock in a margin account • The brokerage firm may use a stock loan finder to locate another firm with the needed shares • The first firm deposits collateral with the second firm (T-bills or cash) • Part of the interest is used to pay a finder’s fee to the stock loan finder

  28. Stock Lending’s Lucrative Nature • Advantages of stock lending • Disadvantages of stock lending

  29. Advantages of Stock Lending • Stock lending is very lucrative • In 1999, the total income to stock lenders approached $1 billion • Stock lending is popular when markets see increased merger and acquisition activity: • Merger arbitrage involves buying shares of likely takeover candidates and short selling shares of the anticipated acquirer

  30. Advantages of Stock Lending (cont’d) • Stock lending can be used by brokerage firms to finance the margin purchases of their customers

  31. Disadvantages of Stock Lending • A customer potentially gives up the right to vote: • The short seller is essentially a negative owner • Some risk is associated with the possibility that the stock borrower might not return the securities • Stock loans are “marked to market”

  32. Regulatory Concerns • Stock lending does technically not fall under SEC jurisdiction • Does not involve the purchase or sale of securities • A possible area of abuse lies in the lending of shares in cash accounts • Cash account holders do not sign hypothecation agreements

  33. Long/Short Portfolios • Short selling is an element of a hedging strategy called building a long/short portfolio: • Combines elements of speculation, fundamental stock analysis, and hedging to reduce risk • Sells overvalued shares and buys undervalued shares

  34. Certificateless Trading • The difference in settlement procedures across countries can cause significant problems • E.g., U.S. settlement takes 3 business days versus 6 weeks in France • Computer automation makes it possible to process some types of transactions almost immediately • E.g., newly issued U.S. government bonds are registered in book entry form only

  35. Program Trading • Program trading: • Is not easy to define • Can be used to mean any computer-aided buying or selling activity in the stock market

  36. Program Trading (cont’d) • The Wall Street Journal defines program trading as the simultaneous purchase or sale of at least 15 different securities with a total value of $1 million or more

  37. Program Trading (cont’d) • Stoll and Whaley elements of program trading: • Portfolio trading • Computerized trading • Computer decision making

  38. Program Trading (cont’d) • Program trading is also the generic term used to describe any strategy that instantaneously recommends buy or sell order because of apparent arbitrage • E.g., buy futures and sell stock if the basis is theoretically too small • E.g., buy stock and sell futures if the basis is theoretically too wide

  39. Program Trading (cont’d) • Program traders fall into one of two groups: • Institutions that buy stock index futures and T-bills to create the equivalent of an index portfolio • Institutions that combine a well-diversified stock portfolio with short position in stock index futures to create synthetic T-bills

  40. Program Trading (cont’d) • Program trading has a bad name as it may increase security price volatility • Many professional traders and investment managers believe that program trading benefits the public • Helps reduce commission costs

  41. Role of Derivative Assets • Process of education • Getting board approval

  42. Process of Education • People think derivatives are speculative • Various exchanges offer seminars on ways in which derivative assets can be used in conservative portfolios • E.g., risk management conferences by CBOE, CBOT, CME, LIFFE • Derivative asset education is designed to give people more choices

  43. Getting Board Approval • Once the portfolio manager is convinced of futures and/or options, he must convince: • Boards of trustees • Supervisors or • Fund beneficiaries • The manager should be able to explain the merits of derivatives using everyday language

  44. The Chartered Financial Analyst Program • History • The CFA program exams • CFA program themes

  45. History • The CFA program began in 1959 when the Institute of Chartered Financial Analysts (ICFA) was formed • Promotes investment education and ethical behavior • Awarded the first charter in 1963 • The Financial Analysts Federation (FAF) merged with the ICFA in 1990 to form the Association for Investment Management and Research (AIMR)

  46. The CFA Program Exams • To earn the CFA designation, candidates must pass three separate exams taken at least a year apart • Each CFA exam is given only once per year

  47. The CFA Program Exams (cont’d) • Level I is multiple choice: • Covers basic tools and inputs to the investment valuation process • Level II is essay, valuation, analysis, and problem sets • Emphasizes security valuation and specialized topics

  48. The CFA Program Exams (cont’d) • Level III is essay, valuation, analysis, and problem sets • Covers portfolio management

  49. CFA Program Enrollment

More Related