China Fire

MSc I  nvestment Management

Revision Topics and Sample Questions

Asset Allocation

• Strategic vs. Tactical Asset Allocation (SAA vs. TAA): what is the difference and which decision is more important one?  Long run to follow; alter it a little bit for short term. SAA is more important, generating more return. TAA is smaller(maximum 20%) . The paper in the note (mentioned or went through in the class), the pic, the year, name in the paper.
• Approaches to SAA: Capitalisation-based (two lines), Mean-Variance Optimisation (we use more his data, mini 36 month, we use sth that may be time varying in next 5 years in SAA, discussing problems about it, a great paper on it), Following the median manager and Liability Driven Investment (latter more approp for pf, cuz the construction of it, first to match debt, then generate extra) – comparison of methods and evident problems with MVO optimisation and Following the median manager approach…..Risk parity (calculation) , trend following, momentum

Why pension fund alter from… to …

Motivation behind those strategies

Comparison questions (outline the difference! Not description about what you now about it)

• SAA of UK pension funds in recent years

Short question, how has aa in uk pf changed in past 10 yr. moved away 40-60 to more alternative investment, cuz lower correlation with traditional assets when they are not doing well. Graphs in the note.

• Global Asset allocation: risk reduction potential, home bias and country vs. industry effect

Inter diversification. The case in class, why investing this way(risk and return)

Increasing correlation appears, better results in buying different industry across country, rather than.

• Insured AA: CPPI strategy, example and feasibility of strategy

How to rebalance, read numerical example.  Find feasibility.

• Return decomposition analysis: allocation, selection and interaction effect

Sample questions:

1. The SAA decision is more important than TAA one. Discuss this statement.
2. Majority of pension funds use either following a median manager or LDI approach to SAA. Explain the difference between the two approaches.
3. Mean variance optimisation is of little use in SAA due to its practical shortcomings. Discuss this statement.
4. When constructing a European equity portfolio, are you more likely to achieve better diversification across sectors or across countries? Explain your answer.
5. Company ABC has majority of its operations in the UK and some in Europe and Japan. Its employees are covered by defined benefit pension plan the average age of employees is 36. Their pension fund asset allocation is under review and they are considering investing in: UK small-cap equity, UK large-cap equity, European equity, UK Government bonds, UK corporate bonds, MSCI World index and cash. Give a suggestion of asset allocation for ABC pension fund using asset classes they are considering. Which other assets or asset classes would you suggest to be included in ABC pension fund? Explain your rationale.
6. Explain how the CPPI strategy works. Under what market conditions is it ineffective?
7. Assume that you are an asset manager following a Constant Proportion Portfolio Insurance (CPPI) strategy. The current value of your portfolio is £125M, out of which £40M is invested in the FTSE 100 index and the remaining amount in 10-year UK Government bonds. The minimum value of the portfolio that you can afford to have is £105M. If the current FTSE 100 level is 4500, but it rises by 5% in the near future, how would you rebalance your portfolio to take into account this change in the market conditions? Explain this strategy, all your workings and use a graph to explain the hypothetical payoff of this strategy under various market conditions.
8. What is the difference between allocation effect, security selection effect and interaction effect? Use an example of your choice to explain how you would calculate each of these effects in a portfolio and the total value added for that portfolio (i.e. to calculate this, assume benchmark weight for each asset class, return % for each asset class, active portfolio weight for each asset class and active portfolio return % for each asset class) .        

Portfolio Performance Evaluation

• Return based performance measures
• Sharpe ratio
• Treynor ratio
• Sortino ratio
• M-squared
• Jensen’s Alpha
• Information ratio
• Fama French Three Factor Model
• Carhart Model
• Fama-French five factor model
• Conditional performance
• Measuring performance of market timing funds
• Measuring performance of hedge funds
• Measuring performance persistence
• UK mutual funds performance: luck or skill?

Calc time weighted return.

Know the Equations for all! To interpret and calc them and compare them

Unsys risk – sharpe treynor. Same ranking.

Downside risk- reference point. Investors only care semi deviation.

Mm shifting over

Alpha, managers’ ability. Calculate it as the difference actual-expected.

Three factor alpha represent

Carhart alpha represent

5 factor alpha represent.

Conditional  alpha, alpha change as beta change… paper in the note.

Two line (method) for market timing fund. Adjust it using dummy or ???

For hf, why sharpe and ir are not good.

Contingency table. How to calc and interprete the numbers in table.

Last graph summery. No good persistence, but bad persistence

Sample Questions:

1)  Consider mutual fund portfolios with the following characteristics:

The risk free rate is 5.5%. The return and the standard deviation of the benchmark portfolio are 0.15 and 0.06 respectively. Rank portfolios according to Sharpe ratio, M-squared, Treynor ratio and Jensen’s alpha and compare their performance with the benchmark. Interpret your results.