CFA Level 3 PM

4 qualities in an effective process

1) account for all the portfolio's return or risk exposure 2) reflect the investment decision-making process 3) quantify the active decision of the PM 4) provide a complete understanding of the excess return/risk of portfolio

Advisor-Client Interactations:

1) adviser understands the client's fin goals and characteristics...the psychology and emotions underlying the goals, 2) advisor maintains a systematic approach to adising the client (does not require large scale changes in methods to include BITS), 3) advisor invests as the client expects, results are communicated in a way that takes into account the client's characteristics (understand the motivations of the client, not just the goals), 4) relationship benefits both client and advisor...clients feel understood...not risk tolerance questionarires provide only broad guideliens for asset allocation and should be used in concert wit behavioral assessment tools

3 broad approaches to asset allocation:

1) asset only (focus solely on the asset side of the investor's balance sheet...MVO considers only expected return, SD, and correlation of the asset classes), 2) liability relative: choose an asset allocation in relation to the objective of funding liab (ie surplus MVO, liability-hedging portfolio + risky portfolio...refered to as LDI) 3) goals based (used primarily for individuals and families...specify asset allocations for sub portfolios, each of which is aligned to specific goals...each goal is associated with a specific type of cash flow, a time horizon, and a risk tolerance)

When care about drawdowns

1) can see robustness/reliability of investment, portfolio construction and risk mgmt. was any action taken part of the investment process...was there a misalignmoent of interests...or simply panic overreaction

3 tools for addressing a concentrated position in a public stock

1) outright sale, 2 hedging, 3) monetization

Goals based planning buckets what are the three buckets?

1) personal risk bucket, 2) market risk bucket, 3) aspirational risk bucket

Coinsurance

%age insurance company pays above the deductible

Financial Stages of Life what are the 7 stages of financail life...

(1) education phase (devlopment of human capital...i.e. investing in education...little/no focus on savings and risk mgmt.) (2) early career (generally lasts to mid 30s...significant family and housing expenses...human capital most likely largest asset) (3) career development (35-50...upward career mobility and income growth...retirement savings begin to accumulate at a rapid pace) (4) peak accumulation (51-60...reached or are moving twards max earnings...begins to reduce investment risk...stress income objectives...high career risk) (5) pre-retirement (61-65...risk reduction, tax planning...less volatile investments...retirement plan distribution options) (6) early retirement (first 10yrs of retirement...most active period of retirement...period of comfortable income and sufficent assets...some seek new career or job with less stress) (7) late retirement (length of time unpredictable...ongevity risk...health issues could impact financial postiion...cognitive decline raises issues of trustees, POAs)

PV (Spending needs) formula

(sum of probl of survival * spending )/(1+r)^i

Types of investment accounts

1) taxable: investments are made on an after-tax basis...returns are taxed as previously discussed 2) tax deferred accounts: contributions are typically made on a pretax basis (i.e tax deductible)...funds accrue tax free, all withdrawls are treated as ordinary income (said to have front-end loaded tax benefits) 3) tax free accounts (back-end loaded tax benefits)...contributions are not tax deductible, but all retruns are tax free

Typical Major Tax Categories Income, wealth, consumption describe each

1) taxes on income (interest, dividends, realized and unrealized capital gains) 2) wealth-based taxes (property and transfers) 3) taxes on consumption (sales and value-added taxes)

Funding Ratio

: MVa/PVL

ACTR

: absolute contribution to risk (measure how much the asset class contributes to SD portfolio)...ACTR = weight * MCTR

Rebalancing

: adjusting portfolio weights to more closely align with the SAA due to normal changes in asset prices (other adj. are not rebalancing)...rebalancing policy document in the IPS (typically higher expected return assets will grow faster than the portfolio the portfoliohigh return assets also higher risk assets...overall portfolio risk rises and concetrates)...calendar rebalancing: periodic basis (monthly, quarterly, annual)...% range rebalancing: %age of the portfolios value around target values, act as trigger points...may be accesses monthly or quarterly...proportional trigger points reflect target weight

Consider two asset classes, A and B. Asset A has two times the weight of B in the protfolio. Under what condition would B have a larger ACTR than A

ACTR = Weight * Beta * Portfolio Vol the beta would have to be more than twice as large as the beta of A for B to contribute more to portfolio risk than A

Institutinoal Investors Governance framework:

BOD and investment committee (establish investment policy SAA, define risk appetite, set investment strategy, monitor investment performance)...implment through an investment office...can be internal (banks/insurance) or external

Perfect Self Interest

Humans are perfectly selfish

Prob on OR formula

P(a) + P (b) - P(a)*P(b)

HML

The HML beta coefficient can also take positive or negative values. A positive beta means that a portfolio has a positive relationship with the value premium, or the portfolio behaves like one with exposure to value stocks. If the beta is negative, your portfolio behaves more like a growth stock portfolio.

Perfect Rationality

ability to reason and make beneficial judgements at all times

Semi-Strong Form

all publicly available info is reflected in prices...both technical and fundamental analysis will not generate excess return...event studies...look at the effect of similar events to different companies at different times...returns to active mgmt.. typipcall zero to negative

Direct market access (DMA)

allows buy-side PMs/traders to access the order book of the exchange directly through broker's tech infrastructure. small trades in liquid electronic markets

What is goal based planning talk about psych and how it shows an investor riskeri allocation choices they are making

allows the advisor to incorporate psychological considerations into asset allocaiton. This concentration highlights the consequences of selecting an risier asset allocation than is appopiate for a paritcular investor. The goal based methodology extends the Markowitz framekwork of diversifying market risk by incorporating the 3 buckets.

Indemnity Plan talk about provider optionality and fees

allows the insured to go to essentially any medical service provider but the insured must pay a specified %age of the resonably and customer fees

Insurance Does it byapss probate? Does it provide creditor protection? Is it recognized in most countries? Discuss liquidity and insurance

also bypasses probate also provides creditor protection (assets below to the insurer) insurance recognized in almost every country (unlike trusts) can also be used as a source of liquidity for a beneficiary (Help pay inheritance tax on illiquid assets) beneficiary can be discretionary trust for the ultimtae beneficiary

When is an asset allocation optimal from a risk-budgeting persepctive

an asset allocation is optimal when the ratio of excess return (over the rfr) to MCTR is the same for all is the same for all assets

Capital assets:

an ongoing source of something of value

Risk Attribution

analyzes the risk consequences of those decisions (absolute or benchmark relative terms)

Factor model based benchmarks

are ambiguous, not specified in advance, may not be investable (many ways to get value exposure) Signs to tell: factor timing, using a factor approach

Added Value (BPS)

arrival cost - estimated pretrade cost

Manager universe (manager peer group)

broad group of managers with similar investment disciplens expected to beat median manager fails all tests of benchmark validty

Custom security based

built to reflect investment discipline of a specific manager satisfies all benchmark validty criteria will refect investment process constraints

Pure Longevity insurance

buy now, fixed payments, being late in life (80-85yrs)

Consumable/transforable assets:

commodities

Market focus (Macro BFMA):

detects and describes market anomalies...markets are subject to behavioral effects

Bonds (constraints):

generally accessible to large and small investors

Non-forfeiture clause in whole life insurance policy think in terms of benefits and missed premium payments

gives the option to recieve some portion of the benefits if a premium payments are missed (i.e. before the policy laps)

How to raise Dl

issue intermediate/LT debt use subordinated capital structures (CoCo bonds) perpetual preferred Futures and swaps

Evaluating Trade Execution

measure execution quality of a trade...measure overall performance of the trader/broker/algo

Real estate (constraints):

smaller asset owners may need to consider co-mingled funds for diversification

Investment Philsophy

the managers underlying assumptions about the factors that drive performance...ex. Market efficiency: assumptions lead to passive or active strategies... passive: seek risk premiums from factor exposures... active: security mispricing can be both identified and exploited...

Upside capture

when benchmark is positive...vice versa with downside capture

If one of the MVO graphs has mroe assets, what are some of the tehcniques that the person could have used to improve that characteristic

1) Black-litterman model (addresses input sensitivity by tiling return inputs towards investor views 2) reverse optimization (addresses input sensitivity by anchoring expected retrusn implied by the asset class weights of a proxy for gloobal market weights 3) constrainted asset class weights

Calculating Utility and recommending and justify a strategic asset allocation

1) CALC MUST BE DONE IN #...don't use % even tho returns and vol are quoted in % 2) if the client says they need to take out a certain $ amount in X months, then see how much that $ amount is of the entire portfolio as that will be the hurdle rate 3) from there calc prob of return which is (expected return of portfolio - hurdle)/SD of portfolio

Marital Property Rights community property regimes seperate propoerty regimes

1) Community property regimes: each spouse has an indvidible 1/2 interest in income earned during marriage...upon death souse gets 1/2 of the community property (other 12 transferred throuugh will)...bequeathingcomesafter 2) seperate property regimes: each spouse is able to won and control property as an individual

What are the three trade cost measurements:

1) Execution cost: shares that were transaction...market impact = price drift... 2) Opportunity Cost: unexecuted shares 3) Fixed Fees-explicit

Behaviorl Biases in AA:

1) Loss aversion: may interefere with an investors ability to maintain the SAA through periods of negative returns...can be mitigated in goals-based investing (fund high-priority goals with Low risk assets) 2) Illusion of control may result in: 1) extreme TAA (all in/all out market calls), 2) belief in superior resources (institutional investors), 3) excessive trading, use of leverage, 4) eliminating/shorting asset classes...can be mitigated by using the GMP as the starting point in developing the SAA 3) Mental accounting: goals-based investing incorporates this bias in the process 4) Representative bias: TAA particularly susceptible to this bias (ie return chasing)...regulate with an objective SAA process and a strong governance framework (pre-specified allowable TAA ranges) 5) Framing Bias: choice of asset allocation may be influenced merely by the manner in which the risk/return tradeoff is presenting...mitigate by presenting risk in multiple ways

Meaning of best execution (Trade Governance)

1) Meaning of best execution: involves identifying the most appropriate trade-off btw: a) execution price, b) trading costs, c) speed of execution, d) likelihood of execution and settlement, e) order size, f) nature of trade....firm must take all sufficient steps to ensure best execution...not just best price at lowest costs

A trade policy doc should include:

1) Meaning of best execution: involves identifying the most appropriate trade-off btw: a) execution price, b) trading costs, c) speed of execution, d) likelihood of execution and settlement, e) order size, f) nature of trade....firm must take all sufficient steps to ensure best execution...not just best price at lowest costs 2) Factors determing the optimal order execution approach: urgency of order, rationale for a trade, characteristics of securities traded, characteristics of the execution venue used, investment strategy objectives 3) List of eligble brokers and execution venues: reveleant factors: quality of service, reputation, speed of execution, willing to do principal trades, financial stability, settlement capabilities, cost copmetitivness 4) Process used to monitor execution arragements: all brokers and execution venues used should be subject to ongoing monitoring for reputational risk, irregularities, criminal actions, and financial stability...use of a best execution monitoring committee...firm wide responbility for trade execution monitoring...trading records stored and accessible for several years

Understanding private clients (what is the information needed)

1) Personal Information: 1) family situation (martial status, children, ages, plans for children), 2) employment/career (future career/busienss/retirement aspiration) 3) source of client's wealth, 4) explicity return objectives (min absolute or relative return targets? meet specific goals?), 5) investment preferences (liquidity, esg, etc.), 6) financial objectives (goals) and risk tolerance 2) Financial Info: assets, liabilities, and cash flows; projection of expenses, planned disbursements, etc. 3) other relevant info: wills, trusts documents, life & disability insurance, decision making parameters (i.e. who can approve or change IPS, approve trades, etc.), serivce needs and expectations 4) tax considerations: 1) common tax categories: taxes on income (cap gains, divident, interest, income, etc.), wealth-based taxes (property, gift, etc.), and consumption/spending tax (restaurants, cigs, etc.)... 2) basic tax strategies: a) tax avoidance (tax free accounts, tax free gifts), b) tax reduction (tax efficent strategies like munis or low fund turnover), c) tax deferral (defer gains, retirement accounts)

Trade strategy recap

1) ST alpha 2) LT alpha 3) risk rebalance 4) cash flow driven (client, equitization)

What are the investment risks in single asset concentration what are the three risks in a single asset (hint same broad risks in a company with real estate)

1) Systematic risk (market and economic) 2) Company specific risk (idoynscartic) 3) Property specific risk (environmental and concentrated tenant positions)

Portfolio Construction approaches Discuss the differences in traditional and goals based investing

1) Traditional Approach: 1) identify asset classes, 2) develop capital market expectations (expected return, SD, correlation), determine portfolio allocation (typically mean variance optimization), asset constraints, implment the portfolio (active or passive, manager selection, security selection, factor focus, etc.), determine asset location (tax expempt, deferred, etc.) 2) goals based investing approach: same process as above but: 1) align investments with goals (assign investment to goals to determin portfolio alloction), 2) perform MVO for each sub portfolio, 3) goals states as max vol or min por of success

Effective gov models share 6 common elements:

1) articulate the long and ST objectives of the investment program: typically a return objective, also meet some future obligations, maintain some level of liquidity, minimize future needed contributions, etc....risk tolerance (liquidity risk, vol, risk of loss) 2) allocate decision rights and responsibilities among the functional units in the governance hierarchy effectively: likely to vary depending on size of investment program; knowledge-skills-abilities of internal staff...delegation should be to those best qualified to make informed decision, 3) specicfy the process for developing and approving the investment policy statement: following features: introduction, describes the purpose and scope of the document itself and describes the asset owner, statement of investment objectives, investment constraints, duties and responsibilities (investment committee, invesmtne staff, 3rd party providers), investment guideliens, reporting, 4) specify processes for developing and approving the strat asset allocation (investment committee typically retains approval of the SAA decision...also includes information relevant to rebalancing), 5) establish a reporting framework to monitor the program's progress toward the agreed on goals and objectives: should address—performance evaluation, compliance with investment guidelines, progress towards states goals, 6) periodically undertake a governance audit: ensure established policies, procedures, and governance structures are effective, should be performed by an independent 3rd party

Portfolio Reporting what will the WM do if its a goal based portoflio strategy wrt reporting? what are the 7 items they will include in reporting?

1) asset allocation report 2) performance summary 3) detailed performance by asset class and by individual securities sometimes 4) historical performance (since inception) 5) contributions/withdrawls 6) purchases and sales 7) currency exposure wealth manager may add economic/market commentary letter if goals based investing is used--> reporting may focus on progress towards the goals (vs. performance of asset classes/securities) benchmark reports--> performance by asset class relative to the bencharmk

Parts of the IPS Discuss (Investment objectives, investment parameters, portfolio allocation, portoflio management, duties and responsbilities, and IPS appendix)

1) background and Investment Objectives: discusses relevant accounts and any other investment assets outside the portfolio + any cash flows from external sources 2) investment parameters: a) risk tolerance (ability + willingness), b) investment time horizon (typically given as a range), c) asset classes used, d) other investment preferences (ESG, legacy holdings, etc.), e) liquidity preferences (cash reserves, pending liquidity needs), f) constraints (restrictions on investments and startegeis) 3) portfolio asset allocation: a) target allocation for each asset class, b) SAA (target and upp/lower bounds for rebalancing), TAA (asset class target ranges) 4) portfolio management: a) discretionary authority (ability of manager to act without client approval), b) rebalancing (methodology and frequency of reviews (time based or threshold based), c) tactical changes (if allowed, when and to what degree), d) implementation (types of investment vehicales like MF, etfs, etc and use of outside managers) 5) duties and responsilbities: a) wealth manager responsibilities (developing the SAA, investment recommendations, monitoring, rebalancing, cost management, the use of derivatives and leverage, drafting/maintaining the IPS, performance reporting, voting proxies...some prehaps a 3rd party responsilbitiy) 6) IPS appendix: a modelled portfolio behavior with capital market expectations

What are the two types of cognitive error categories

1) believe perseverance biases: tending to cling ot one's previously held beliefes irrationally or illogically (conversatism, confirmation, represntativness, illusion of control, hindsight)...

Trade Policy (what are the factors to make sure a firm's trade policy is in-line with regulatory reuirements and client's best interest)

1) best execution price and lowest trading cost per transaction 2) speed of execution 3) the alignment of execution approach and execution horizon with investment process 4) the lilihood of execution to be optimal

Equity Attribution (BHB vs. BF)

1) brinson-hood-beebower (BHB)...views allocation from an absolute positive or negative perspective 2) Brinson-Fachler (BF)...views allocation from a relative perspective versus total benchmark return

what are the 5 types of soverign wealth funds Budget Stabilization, Development, Savings, Reserve, and Pension Reserve Fund What are each

1) budget stabilizaiton funds: insulate the budget and economy from commodity price vol and external shocks (covid) 2) development funds: allocation resources to socio-economic projects, typically infrastructure 3) savings funds: to share wealth across generations by transforming non-renewable assets into diversified financial assets 4) reserve funds: reduce the negative carry costs of holdings reserves or to earn a higher return on ample resources 5) pension reserve funds: These are used to save and invest to meet future pension liabilities of governments.

What are accrual equivalent returns and tax rates used for

1) can be used to measure the tax efficiency of different asset classes (allocation) or different portfolio mgmt. styles 2) shows clients the tax impact of lengthening the average holding period of stocks they own 3) can be used to access the impact of future tax law changes

the 7 types of general tax regimes Talk about each: common progress regime, heavy dividend tax regime, heavy capital gains tax regime, heavy interest tax regime, light capital gain tax regime, flat and light regime, flat and heavy regime

1) common progress regime: progressive tax rates for ordinary income, favorable treatment for interest, dividends, capital gains 2) heavy dividend tax regime: progressive, dividends taxes as ordinary income (interest and capital gains favorable) 3) heavy capital gains tax regime: progressive capital gains taxed as ordinary income (dividend +interest favorable) 4) heavy interest tax regime (Progressive, interest taxes as ordinary income (dividend +capital gains favorable) 5) light capital gain tax regime (progressive for all, capital gains favorable) 6) flat and light regime: flat tax, dividend and interest + capital gains favorable 7) flat and heavy regime: flat for all, interest favorable

The 4 types of foundations 1) community foundsations: 2) operating foundations: 3) corporate foundations: 4) private grant-making foundations:

1) community foundsations: make social/educations grants for the benefit of a local community 2) operating foundations: operate a not-for-profit business for charitable purposes 3) corporate foundations: established by busienss, funded from profits 4) private grant-making foundations: established by individual donors/families to support specific types of charities

Who are the key stakeholders for soverign wealth funds

1) current and future citizens 2) government 3) external asset managers, SWF mgmt. investment committee

Determine a portfolio allocation that is closest to BPT optimal portfolio

1) define the allocation (BPT investors construct a portfolio in layers to satisfy investor goals rather than be mean-var effificent. The investor's expectations of returns and attitudes toward risk vary btw the layers) 2) collect relevant data (identify the portfolio allocation choices, the expected return on the riskless portfolio and risky portfolio, determine return target (target portfolio/oroginal portfolio), determine min threshold you need to have and the prob of needing to achieve it) 3) calc: risky portfolio weight * portfolio amt * risky portfolio return + riskless portfolio weight * portfolio amt * riskless portfolio return if above the threshold needed, sum to get the probability

Discuss how the prob of not being able to pay future liab when the come due is or is not addressed by each of the major approaches to liab relative asset allocation

1) determine if q is looking for singele period or multiple period 2) if multiple period than chose integrated asset liability approach

Overconfidence vs. Availability bias

1) determine what type of bias they are (cognitive or emotional). In this case overconfidence is an emotional bias while availability is an info processing (cognitive basi) 2)

Distinguish btw 2 assets and contrast potential relevance in asset only and liabily relative context

1) discuss what they share 2)

Discuss limitations of just basing your decision off the sharpe ratio

1) does not capture VAR or funded ratio of the portfolio 2) does not confirm the absolute level of risk

Effective Investment Governance include

1) establish LT and ST investment objectives (at the core is the return requirement, willingness and ability to tolerate risk, funding obligations, liquidity) 2) allocate rights and responsiblities within the gov system (dependent on investment pgoram size, availability of internal staff, knowledge, skills, investment program complexity, resource availability, capacity constraints) 3) specify processes for creating and IPS 4) specify process for creating SAA (set at the IC, constructs IPS, investment results are simluated over appropiate time horizons, riks/returns attributes of all possible asset allocations are considered, good gov also specifies rebalancing) 5) apply a reporting framework to monitor the investment program's stated goals and objectives (report should outline the current status of the pgoram, where it is in relation to its goals/objectives, how mgmt. decisions have added or subtracted value, should be done regularly). 6) periodically performan a goverance audit (3rd party should evaluate structure to make sure it is following good practices, effecitve gov aims to min decisin-reversal risk which is risk of reversing investment decisions at the worst possible time.)

Ethical Consideratoins in PWM talk about fiduciary duty and suitability, KYC, confidenentiality, conflicts of interest, and compliance considerations

1) fiduciary duty and suitability: given client circumstances: obligation to delver a high standard of care when acting for the benefit of another party 2) KYC: obtain essential facts about every client for whom they open and maintain an account 3) confidentiality 4) conflicts of interest: investment product commission, fees based on actiuity or AUM Compliance considerations: regulatory requirements for dealing with clients, varies by jurisdiction

How to calc additional amount of life insurance coverage needed

1) first calculate capital needs and you will likely be doing an annuity for it as long as the discount rate > growth rate can use this formula to get the i for the calculatory: ((1+discount rate)/(1+growth rate))-1 calc pv for all the capital needs NEED TO COME BACK AND FINISH THIS!! 18 from Reading 32

Characterizing the Liabilities:

1) fixed vs. contingent cash flowstiming and amount depends on tsome future uncertain event (complicated things)...amount and timing fixed in advance (non-contingint which is easier to deal with), 2) legal (DBPP) vs. quasi-liabilities-->cash payments that are expected to be made but are not liabilities (endowment), 3) duration and convexity of liabity cash flows (hedging portfolio, immunization strategies), 4) value of liabilities as compared with the size of the sponsoring org (ability to use variant 2 portfolio approaches), 5) factors driving future liabity cash flows (inflation, economic conditions, interest rates, premiums)—ability to effectively build a hedging portfolio (may introduce basis risk), 6) timing considerations, such as longevity risk, 7) regulations affecting liability cash flow calcs

Evaluating Success talk about goal achievement, process consistency, portfolio performance, defiintino of success

1) goal achievement: do not ask if investment strategy succeeded during last period but whether it is likely to succeed in meeting client goals without requiring meaningful adjustments 2) process consistency: has the plan been followed with respect to 3rd party managers, rebalancing, tax considerations, unique circomstances, tactical allocations 3) portfolio performance: absolute and relative risk and return; downside risk consistent with risk tolerance 4) definitions of success: manager and client should have the same definitino of what success looks like

Governance structure (instutional investor context will have 3 levels):

1) governing investment committee (BOD members or staff), 2) investment staff: large or small in house staff, 3) third party resources: investment managers and consultants, custodians, actuaries

Behavioral COnsideration in retirement planning Discuss: Heigtnened loss aversion, consumption gap, annuity puzzle, return preferences

1) heightened loss aversion (as clients age...implications for asset classes used, weights, return assumptions) 2) consumption gaps: retirees spend less than expected 3) the annuity puzzle: individuals tend not to prefer annuities 4) preference for investment income over capital appreciation

What are the 2 ways of Calculating life insurance needs Human vs. needs analysis

1) human life value method: replace the estimated net contribution to family finances that the insured woudl generate 2) needs analysis method: meet the financail needs of the survivors

Understanding client goals

1) identify time horizon 2) IDENTIFY WHAT RISK bucket (look for words like "desire" vs. "need" as desire indicates room for error and likely different asset mix (more equity like)

Annuity Classifications (immediate annuity and deferred annuity)

1) immediate annuity: an amount of money is paid to the insurance company in exchange for specified future monthly payments over a specified period of time (# of years or life of the annuitant) 2) deferred annuity: the income stream begins at a later date...annuity amount based on how much was put up...attempts to provide protection against longevity risk 3) deferred variable annuity: like a mutal fund but structured like an insurance contract...individual can choose an investment option (limited)...typically higher MERs...may include a death benefit (beneficiary would recieve 100% of investment...i.e. payment to insurance company)...contract holder has the right to exit the contract with penality....does not guarantee lifetime income-->must by converted to an immediate payout annuity Rider: guaranteed minimum withdrawl benefit: excess paid to beneficiary, deficiency paid by insurance companies 4) deferred fixed annuity: an annuity payout that begins at some future date...at any point prior to annuitization, investor can cash out (with penality)...once in retirement you can cash out and begin payments (then it is no longer deferred now an immediate fixed annuity) 5) immediate variable annuity: pay a sum of money for an annuity whose payments are based on the performance of the assets purchased 6) immediate fixed annuity: pay a sum today for an annuity that promises a fixed income for life

What are the 2 options for implementing investment strategies (Think fido's offerings re megan and ford)

1) individual separately managed and 2) pooled or comingled

Portfolio Construction (target funds, naive diversification, company stock)

1) inertia and default: most plan members (DCBP) tend not to change asset allocation over time (even though risk tolerance should be)...most plan members stick with default options in terms of contribution rates and investment funds...counteract: target date funds automatically change asset allocations over time BUT such funds are 1 size fits all solutions 2) naïve diversification: simple heuristics1/n diversification...divide money equally among their investments regardless of the underlying composition of the funds...framing bias on diversification (more diversified since you own more products), 3) investing in the familiar (company stock): a) familiarity and overconfidence effect...underestimate risk due to familiarity with employing company...overconfidenct in their estimates of company earnings, b) naïve extrapolation of past retursn...plan members at companies whose stock has done well in the past tend to hold larger %ages, c) framing and status quo effect of matching contributions...higher allocation to company stock when employer is matching in company stock, d) loyalty effects, e) fin incentives...ability to purchase stock at a discount (typically with restritions on sales)

Limitations of Using BITS:

1) investors may exhibit both cognitive and emotional biases, 2) investors may exhibit characteristics of multiple BITs, 3) investors will likely go through behavior changes as they age (as investors age, risk tolderance drops and emotional biases dominate), 4) investors are likely to require unique treatment rather than one-size fits all per BIT, 5) investors act irrationally at different times and without predictability

Based only on the graph, discuss the investment characteristics of a asset class in efficent portfolios

1) likely won't be the highest or lowest vol asset class 2) Note where the asset class drops out (likely provided diversification beenfits to the portfolio ie low correlation benefits) 3) state the vol level it drops out on

Liquidity (constraints):

1) liquidity needs of the asset owner...vary by goal and the time horizon and may be a regulatory constraint, 2) liquidity characteristics of the asset classes in the opportunity set...allocations to illiquid classes may be influenced by the available financial resources of the asset owner

Identifying if a current asset allocation for a client is expected to satisfy their desires in a monte carlo simulation

1) look to see if the problem gives the person's age and expected survival (that is the age you need to see if their assets will be above/below the desired level) 2) if the the will be less than what is desired than they won't achieve the goal 3) potential mitigations are 1) invest more aggressively (depends on age for suitability), 2) delay retirement, 3) adjust living standards

Private Client Segments compare mass affluent, high net worth, and ultra high net worth

1) mass affluent: financial planning, risk management, retirement planning...typically non-customized solutions, high client/manager ratio, commission structure to fee based, can be discretionary or not 2) high net worth segment: lower client to manger ratio, customized investment management, tax planning, wealth transfer issues; less liquid investments (due to higher wealth), more sophisticated portfolios, requirement for stronger product knowledge 3) ultra high net worth segment: multi generational (time horizons, highly complex tax and estate planning considerations) few clients per manager

Three factors in portfolio performance evaluation

1) measurement (typically relative to a benchmark) absolute return--> what the portfolio achieved over a specific period relative return-->portfolio return -benchmark return...also involves measuring the risk incurred to achieve that return 2) attribution: how that performane was achieved ot how the risk was incurred...explain absolute or relative return...what portion was driven by active management decisions...decopmose excess return into component sources...decopmose risk 3) evaluation: draw conclusions regarding the quality of performance...distinguish manager luck from skill

Insurance Pricing (3 key considerations)

1) mortaility expectation (how long the insured is expected to live): generalized tables and individual specific information. may involve a physical examination. 2) discount rate: net premium --> the discounted value of the future death benefit 3) loading: other factors that add to the net premium to = gross premium... load = other expense (like sales commistion, issuance, monitoring, etc.) + profit

What are the motivations to trade (4 reasons) Profit seeking, rsk mgmt., Cash flow needs, index recon

1) profit seeking: active PMs seek to outperform bencharmk trading securities they believe are mispriced Key consideration is alpha decay: deterioration in alpha once an investment decisoin has been made. Managers with higher rates of lapha decay (trading on daily news flow) need to trade in shorter time frames and therefore have high urgency to minimze info leakage managers execute their trade on multiple venues including less transparent venues called dark pools. Orders entered into a dark venue cannot be seen by other market participants before the trade occurs; hence users know that there is no risk info leakage. This disadv. of dark pools is that traders can't see orders on the other side of the trade, so they don't know the pretrade likelihood of execution short-term may be possible in more liquid markets only (equities, FX, exchange traded derivatives) 2) risk mgmt./hedging needs may involve derivatives or just trades in the underlying securities liquid derivatives more cost efficent (illiquid derivatives negate this adv.) investment mandate may nto allow derivatives (use ETFs or the underling security 3) cash flow needs may involve high or low trade urgency collateral/margin calls-->high redemption-->low (outflows) funds with less liquid holdings will find it difficult to invest new client funds in a short time frame. This may lead to cash draw where the low returns of cash cause the fund to underperform the benchmark. To avoid cash drag, inflows-->may be equitized using ETFs/futures-->until next rebalance or underlying position can be established client redemption: based on fund's NAV using the closing prices of securities. liquidating securities at closing prices, therefore eliminates the risk of selling at prices different to those needed to meet redemptions. When determing which securiteis to sell to meet redemption requests, managers should consider both liquidity and tax implciations. Client driven redemptions typically have a much lower level of trade urgency investing or raising cash--> trade size and liquidity will determin what to buy/sell from a risk return or cost perspective 4) corporate action/index reconsitution/margin calls cash dividends/coupons need to be reinvested margin or collateral calls have high levels of trade urgency index tracking portfolio--> trades usually done "on close" to minimize tracking error active managers with a benchmark may choose to rebalance with index reconstitution

What are the 3 objectives in dealing with a concentrated position Talk about concentration, liquidity, taxes

1) reduce the risk of wealth concentration (emotional and cognitive biases may cause investor to underestimate the riskiness of the position and overestimate its value) 2) generate liquidity in order to diversify and satisfy spending needs 3) optimize tax efficency

Active and passive choices in asset allocation

1) relates to active deviations from SAA. These would include TAA (st focused) and DAA (LT focused) 2) the second choice is investing in active and passive strategies

Strategies for loss control that don't require insurance risk avoidance, loss prevention, loss reduction

1) risk avoidance (don't do certain things) 2) loss prevention (security cameras) 3) loss reduction (sprinkler system for fore) do not insure = risk retnention insure= risk transfer

Private Business Equity Exit Strategy Talk about an MBO vs 3rd party sale talk about strategic vs. finacnail buyers employee stock option plan

1) sale to a 3rd party: strategic buyer: typically will pay highest price; financial buyers: PE/VC 2) sale to insider: management (MBO) or key employees: owner typically holds some portion as a promissory note; employee stock option plan: a qualified retirement plan that can be created by the company and is allowed to buy some or all of the owner's shares....may be a tax deferral benefit...a staged or phased exit strategy

Common Characteristics of Insitutional Investors (scale, horizon, regulatory framework, principal agent, governance framework)

1) scale (Size): a) small <$25mn-->may be unable to access certain investments that require minimum investment....more likely to rely on rexternal managers and investment consultant b) large-->scale benefits given they can access investment and can attract internal asset managers c) very large >$10b --> diseconomies of scale...unable to access niche investments (VC/PE, small cap growth, etc.) typically pushed into private assets, infrastructure assets 2) LT investment horizon: Long investment horizon + low liquidity needs (allow for holdings of alt investments) banks/insurance-->perpectual horizon but typically short maturity holdings 3) regulatory framework: legal, regulatory, tax, accounting (differ by national jurisidction)...key drivers: investor portection, safety/soundness of fin institutinos, integrity of fin markets 4) Governance framework: BOD and investment committee (establish investment policy SAA, define risk appetite, set investment strategy, monitor investment performance)...implment through an investment office...can be internal (banks/insurance) or external 5) Pincipal-agent issues: interest not aligned...agents may be internal or external...ei. high base fee regardless of performance...manged through highly developed governance models, high levels of accountability

Execution Algo classifications

1) scheduled: a) Percent of volume (aka participation algos): as volume increases, algo trades more, trader specifies a participations rate...i.e. 10% for every 100k shares traded, algo trades 1000 shares b) VWAP/TWAP: VWAP: Follows a time slicing schedule based on historical volume profiles...higher %age traded at the open and close...may not be optimal for illiquid stocks (may not complete order) TWAP: follows an equal weighted time schedule...same number of shares for time period 2) liquidity seeking (opportunity algos): trade faster when liquidity shows up across multiple venues...will use exchanges, ATS and dark pools for large quantities appopriate for large order with high trade urgency while avoiding market impact...printing limit order would reveal information (minimizes information leakage), les liquidit, thinly traded or when liquidity is episodic 3) arrival price: trade more aggressively at the beginning of order...called front-loaded strategy...used when momentum is expected in prices appropiate for PM who are risk averse and wish to trade more quickly to reduce execution risk...security is relatively liquid, order is not out-sized (<15% expected volume) 4) dark strategies/liquidity aggregators: used to avoid any info leakage order size is relatively large and may have significant market impact appropiate for illiquid securities, wide bid-ask spreads, pm does not require full execution (low trade urgency) 5) smart order routers (SORs): SOR determines destination with the highest prob of executing a limit order used with small market or limit orders that will have no market impact best used for orders that require immediate execution or for limit orders for which printing the order will not leak info...appropiate for securities traded on multiple markets

Security Characteristics (talk about execution risk for the following type, alpha, vol, liquidity)

1) security type: liquidity and trading costs will vary by exchange...eg gaining EM exposure may be easier/cheaper using ADRs/GDRs 2) short-term alpha: the expected movement in the security price over the trading horizon (i.e. appreciation, deprecation, reversion) alpha decay--> results from price movement in the direction of the trade forecast if info is reflected in prices quickly, decay is fast...requires faster trading 3) price vol: affects execution risk-->risk of an adverse price movement over the trading 4) security liquidity: greater liquidity-->lower execution risk and trading costs bid-ask spreads will indicate both cossts and market depth larger trades-->broken down, traded more slowly

Order characteristics (think size and side) Length of Market exposure orders to execute Urgency in trading larger orders

1) side of the order: if buying in a rising market or selling in a falling market --> market risk exposure order may take longer to execute or cost more 2) size of the order: large order sizes create market impact (i.e. adverse price movement in a security as a result of trading an order) larger orders take longer to trade will usually be traded with lower trade urgency to reduce market impact size best ecaluated in terms of % ADV

Endowment Objective Statement

1) state the purpose of the endowment 2) say it must maintain purchasing power of its assetsin perpetuity while achieving investment returns sufficient to sustain the level of spending necessary to support the scholarship budget 3) the investment objective of the endowment is to achieve a total real rate of return of X% with a reasonable amount of risk

Insurance Basic Elements what are the 8 elements (talk about term, type, benefits, limitaitons contestibility, identify of insured, policy owner, beneficiaries, premium schedule)

1) term and type 2) amount of benefits 3) limitations under which benefits could be witheld 4) contestibility period (Insurance company can investigae and deny claims) 5) identify of insured 6)policy owner (most have an insurable interest) 7) beneficiaries 8) premium schedule and modifications

Who are the parties in an annuity describe the insurer, annuitant, contract owner, beneficiary

1) the insurer: generally an insurance company 2) the annuitant: person who recieves the benefit 3) the contract owner: person who purchases the annuity (typically the annuitant) 4) the beneficiary: the person who would recieve any proceeds upon death of the annuitant if any

Trading behavior and tax implications (4 types) Define each Trader, active investor, passive investor, tax-empt investor what do active mgmt. need to do with alpha so that it justifies not using passive?

1) trader: reconiznes all portfolio returns in the form of annuall taxed short-term gains 2) active investor: gains are longer term in nature, may recieve more favorable tax treatment 3) passive investor: buys and holds passively 4) tax-exempt investor: never pays capital gains taxes active managers must earn greater pre-tax alphas than passive managers to offset the tax drag of active trading

Pros and cons of annuities

1) vol of benefit amount: fixed-constant income stream (predictability); variable-income stream could change considerably 2)flexibility: immediate-->irrevocable (funds are part of the insurance company's overall portfolio); variable-->funds can be withdrawn (funds are in a subaccount). guarantee of income for life and flexibility of withdrawl 3) future market expectations: fixed annuitant locks in whatever rate of return exists at the time of purchase...may wait until rates rise but during that period, life expectancies may rise, which increases the cost of annuitization; variable: annuitant gets higher payments as rates go higher...many limit future growth however...those without growth limits are likely to outpace inflation 4) fees: variable>fixed...immediate fixed annuity prices much easier to compare vs. variable 5) inflation concerns: fixed-->affects real income...are nominal and will not change with inflation...may be riders available tied to inflation 6) payout methods: Life: payments cease at death period certain: payments are for a # of periods only life with period certain: payments have a min term or life...if the annuitant dies within the min term, beneficary recieves the payments for the balance of the term life with refund: min recieved = initial payment - fees joint life: payments continue until both members are no longer living expected benefits of annuities are generally negative...benefit of certainly regarding lifetime income BUT lower potential wealth at death and lower lifetime income ppl with a higher annuity allocation would make sense if: 1) longer than avg. life expectancy, 2) greater preference for lifetime income a) less concern for leaving money to heirs and b) lower income from other sources

Effect of Human Capital (things to think about) wage growth, human capital vol and insurance, lower job performance, geogrpahical mobility, single sorce income, employer specific HC risks, labor based HC, HC with rapid decay rates

1) wage growth vol (some professions naturally have this more than others) 2) most human capital vol is difficult to hedge with insurance factors that contribute to human capital riskiness include: 1) lower job performance (lack of upward mobility) 2) lack of geographical mobility 3) single source of income 4) employer specific human capital 5) routine cognitive/labour based human capital 6) human capital with rapid decay rates

Residence-residence conflict

2 countries claim residence of the same individual, subjecting the individuals worldwide income to taxation by both countries

Source-source conflict

2 countries claim source jurisdiction of the same asset

Retail Investment Approach (home bias, excess trading)

4): excessive trading...disposition effectsell winners, hold onto losers which is driven by overconfidence, 5) home bias (typically >80%...familiority bias with the country)

Calendar Rebalancing

: % range rebalancing... higher transaction costs... higher risk tolerance... higher correlation with rest of portfolio (wider range)... higher vol of the rest of the portfolio-->narrow range... higher vol of the asset class-->narrow range frequent rebalancing while wider range large divergences... corrider width should be set proportional to the asset's vol (vol based-rebalancing)

2 Treatments of cash in MVO

: 1) as a risky asset included in an MVO analysis, 2) as a risk free asse with the MVO producing the risky asset (most efficient)...combine the two: expected return = risky asset return * weight + rfr * (1-weight) Since Human capital and houses are non-tradeable assets

Implementation Choices

: 1) asset class weights: tactical asset allocation and dynamic asset allocation, 2) allocations to asset classes: passive mgmt..-->portfolio composition does not react to changes in CME or to info on investments...active mgmt.-->respond to CME nd insights/info on investments...unconstraint active mgmt.-->benchmark agnostic

Problem allocating to less liquid asset classes

: 1) due to lack of accurate indexes it is more challenging to make capital market assumptions, 2) even if there were accurate indexes, there are no low-cost passive investment vehicles to track them...possible solutions include: 1) exclude less liquid asset classes from asset allocation decisions (the optimization process), 2) include the asset class but attempt to model the specific risk characteristics (factor-based allocation), 3) include the asset class but attempt to model the specific highly diversified characteritics associated with the true asset class (better estimates of expected return, SD, correlation...can use listed real estate indexes, listed infrastructure, public equity indexes, that have characteritics close to their private equity counterparts...may violate asset class mutual exclusvety)

How to identify biases

: 1) interview the client and identify active or passive traits and risk tolerance, 2) plot the investor on the active/assive and risk tolerance scale...if active/passive do not line up with risk tolerance, defer to risk tolerance, 3) test for behavioral biases...confirm the consistency with the specific BIT, 4) classify investor into a behavior investor type

Economies and diseconomies of scale: size of an investor's asset pool maybe

: 1) too small: an allocation may not meet min investment requirements... may not have sufficient gov capacity to develop the required knowledge base for the more complex asset classes or investment vehicles (ie strats); 2) too large: their desired min investment may exhaust the capacity of active external investment managers in certain asset classes and strats

Heuristic Asset Allocation

: 120 minus your age...120-age =allocation to equities...results in a linear decrease in equity exposure, close fit to the general glide path associated with target date funds...

DBPP

: Surplus= MVa - PVl

Rebalancing

: adjusting portfo weights back to the SAA to reflect price drift... benefits vs. coststriggers tax events... if the SAA is optimal, then departures must be sub-optimal (a loss of expected utility)... tends to reduce risk while incrementally adding to returns... rebalancing earns a diversification return such that the compounded growth rate of the portfolio > weighted average compound growth rates of the component portfolio holdings

ST Shifts in Asset Allocation: Tactical Asset Allocation (why level is TAA done, how to determine success, when do you do it)

: business or monetary cycle opportunities, temporary price dislocations... objective-->increase risk adj. return by taking adv of ST market conditions... predicated on the belief that some ST returns are predictable though aren't persistent TAA done at asset class level and is an asset only approach (do not expressly consider liablities)... the SAA is the policy portfolio against which TAA results are measured...The success of the TAA should be judged against the benchmark of the SAA. The size of deviations may often be limited to a range around this allocation. There may also be an allowable range of predicted volatility or a tracking error budget versus the SAA. tactical deviations are usually subject to range restrictions... success of TAA: compare share ratio with policy portfolio sharpe ratio... evaluate the IR versus the policy portfolio... plot realized return/risk vs. SAA's efficient fronter

Efficient Asset Mix

: combination of assets from the opportunity set that max expected return per unit of risk

Tactical Asset allocation

: deliberate ST deviations from the SAA that refelect ST views...active mgmt.. at the asset class level...deviations from SAA usually kept within rebalancing ranges or risk budgets...barriers/monitoring and trading costs (including tax effects)

Dynamic asset allocation

: deviations from the SAA motivated by LT valautions signals or economic views

Risk Parity

: each asset should contribute equally to the total risk of the portfolio for a portfolio to be well diversivied... wi * cov (ri, rp) = 1/n sd^2 (tends to ignore return and allocate entirely on risk) such that ACTR = ACTR2= ACTR3,...sum of all ACTRs = SDp

Endowment model

: emphasizes large allocations to non-traditional investments

An allocation is optimal when

: expected (retrun - rfr)/ MCTR..is the same for all assets and matches the sharpe ratio of the total portfolio

Allocating to less liquid asset classes

: for less liquid asset classes, far fewer indexes attempt to represent aggregate performance, those that do generally under est vol

Tax considerations when rebalancing

: frequent rebalancing exposes taxable asset owner to realized taxes that could have been deferred...must consider trade off: benefits of tax min...merits of maintinaing the targeted SAA

Adding constraints beyond the budget constraint

: helps overcome highly concentrated positions... specify a set allocation to a specific asset, specify an allocation range for an asset, specify an upper limit to an asset class, specify a relative allocation btw asset classes (weight on class a = 2x weight on asset class b)

Strategy Spectrum

: indexingnon-cap weighted indexing (not self-rebalancing)traditional relatively well diviersified active strategiesvarious aggressive and/or non-diversified stratsunconstrained mandates...tracking risk relative to benchmark and active share relative to benchmark increase on this spectrum

After Tax Portfolio Optimization (interest and equity after tax formulas, correlation and taxes)

: interest : return after tax = return pre tax * (1-t)... eqtuiy return after tax = proportion of return attribute to dividend * pre tax return * (1-dividend tax rate) + proportion related to capital gains * pre tax return * (1- capital gains tax rate) adjusted each asset classes expected return and SD for expected tax (some assets may have existing capital gains/losses-->embedded tax liabilities-->requires an adj of the asset's current MV)... taxes reduce the expected return and mutes the vol... correlations btw asset classes remain the same... ie all investment assets are taxable... cost base=current MV... interest income +=40% while dividend and capital gains = 25%

Regulatory and other external constraints

: loval laws and regulations may dictate asset classes that must be held or eliminate others... may be holding requirements to maintain tax exempt status... may be credit-worthiness constraints... may be cultural/religious factors that constrain asset selection

Asset-only objective (with respect to SD and return objective)

: max sharpe ratio for an acceptable level of SD and within constraints of IPS

MVO Describe

: max the expected return for an expected vol level of risk...requires 3 sets of inputs: returns, risk (SD), correlations

Constraints: asset size

: may limit the opportunity set by virtue of: a) the scale needed to invest successfully in certain classes, b) the availability of investment vehicles necessary to implement the asset allocation

Factor-based asset allocation

: move from asset classes to investment factors...factors are similar to those used in multi-factor investment models... ie market size, valuation, momentum, liquidity, duration, credit, vol... each factor is constructued to be a $10 investment with all market exposure removed so correlations of factors will be low

Defining client goals

: needs (90-99% prob), wants (80-90% prob), desires (60-80% prob)

What is the true risk for a portfolio that exists to fund a liability

: not the vol of asset returns...not the performance of an asset portfolio relative to a benchmark or peer group...True risk is that the portfoilio won't pay for the liability...

Size Example

: small cap return (long) - large cap return (short) ...factors are typically based on observed premiums...to get back to total return space, add the rfr to each asset class

60/40 stock/bond heuristic

: some evidence that the global fin asset market portfolio is close to this 60/40 split

Revising the SAA

: typically triggered by a change in 1) goals (change in business conditions affecting the expected cash flows to the fund or change in personal circumstances like marriage, children, etc.), 2) constraints (time horizon: lumpsum payments vs. annuity; liquidity: significant inflow/expenditure; asset size: merging of funds; legal/regulatory), 3) beliefs: changes in the economic environment (CME), changes in trustees or committee members with new beliefs...change in SAA may also happen naturally over time...reduce risk at specific milestones (glide paths)

Resampled MVO

: uses monte carlo simulation to est a large number of market assumptions... generate an efficient frontier for each set... resulting asset allocations are averaged

MVO Constraints

: weights must sum to 1 (budget constraint)...only positive weights allowed (no short positions)

Max expected return portfolio

: will consist of 100% allocation to the single asset with the highest expected return

ACTR/SumACTR

= %age of total risk that each position contributes

MCTR

= beta * SD portfolio

Equal prob rebalancing or corridor

= x * SD

Strategic asset allocation

=policy portfolio Steps to selection: 1) quantify objectives, 2) establish risk tolerance, 3) determine investment horizon, 4) determine other constrained requirements, 5) determine suitable asset allocation approach (asset only, liability relative, goals based), 6) specify asset classes + CME for them, 7) develop a range of asset allocation choices for consideration, 8) test/simulate potential stressors

Instituational Investors small <$25mn--

>may be unable to access certain investments that require minimum investment....more likely to rely on rexternal managers and investment consultant

Contrast, using the info provided above the results of a reverse optimization approach with that of the MVO approach for each of the following: the asset allocation mix the values of the expected returns for US equities and global bonds

Asset Allocation Mix: Asset allocation weights are the inputs for the Reverse opti method and are determined by the market cap weights of the global market portfolio. Expected returns are the outputs as well. (USE CAPM TO SOLVE...MUST USE global market risk premium) the asset allocation weights for the MVO method are outputs of the optimization with expected return,risk aversion, and covariances used as inputs the asset allocation method should included more asset classes.

FIxed Income Attribution (exposure decomposition...a top down approach)

Benchmark has specific factors like duration, yield curve positioning, sectors vs. portfolio which has active decisions against those three items

Soverign Wealth Fund Asset Allocation Budget Stabilization, Development, Savings, Reserve, and Pension Reserve Fund

Budget Stabilization: fixed income and cash Developement: These are driven by the socioeconomic mission of the fund Savings: Growth assets (equities, AI) (typically follow endowment model) Reserve: equity, FI, AI Pension Reserve: large equity, ~10-15% IA (typically follow endowment model)

Describe elements that might affect an university's endowment

Certain financial assets are likely stressed during the same economic circumstances as when the university is so thus won't be that diversified.

Capital Market Expectations

Changes in prices and marketsinvestment opportunity setchanges capital market expectations which impacts SAA

What are private client investment concerns vs. institutional clients concerns: Constraints Think time horizons

Client: different horizongs for different objectives...general rule of thumb is shorter horizon= lower risk tolerance, higher liquidity requirements institutional: long horizon, single stage, single investment objective

Who bears the risk for whole/term life insurance, universal life, fixed annuities, variable life annuitity, variable annuities

Company for everything fixed and universal/whole...put in a general account policyholder for everything else...put into a seperate account so investment risk on policy holder

Macro Attribution (sponsor level)

Decision #1: deviations from the SAA success=overweighting an asset class that outperforms its benchmark (or combined weighted benchmark) Decision #2: selection of investment managers success=selecting a manager that outperforms their benchmark

Investment Objectives of a Sovereign Wealth Fund Development, Savings, Reserve, and Pension Reserve Fund

Development: achieve a real reate of return in excess of real GDP or productivity growth Savings: maintain purchasing power of the assets in perpetuity while achieving investment returns sufficient to sustain the spending necessary to support ongoing gov activies Reserve: achieve a rate of return above the return the gov must pay on its monetiary stabilization bonds pension reserve: earn sufficient returns to max the liklihood of being able to meet future unfunded pension, social security, and or health care liabilites of plan participants as they arise

Bank formula with duration

Equity Duration = (asset/equity) * asset duration - (asset/liab -1) * duration of liab * (change in interst rate/change in yield)

Bank stakeholders (internal and external)

External: shareholders, creditors, customers, credit rating agencies, regulators Interal: employees, mgmt., BOD

Insurance Stakeholders

External: shareholders, derivative counterparties, policyholders, creditors, regulators, rating agneices internal: employees, mgmt. BOD

Value and Growth (value outperforming growth; halo effect)

FF 3 factor model eliminates the value stock anomaly....behavioral explanation: halo effectextending a favorable evaluation from one characteristic to another...ie good growth rate= good investment...potentially leading growth stocks to be overvalued

Differences btw fixed and discretionary distrubtions for a trust Who determines how much to distribute and when?

Fixed: distributions to beneficary occur at certain times or in certain amounts (terms of distribution are pre-determined) Discretionary: trustee determines whether and how much to distribute (trustee has sole and uncontrolled discretion)

Market Risk Bucket what is the goal what allocatino should you ahve in it?

Goal: maintain current standard of living allocations: average risk-adjusted returns; stocks and bonds

Canada Model (what is it and pros/cons)

High AI exposure, active mgmt., insourcing Positives: high value-added potential development of internal capabilities Cons: potentially expensive, difficult to mange

Trade Execution (Strategy Implementation) Higher Touch, Principal Trade, Broker Risk Trades, agency trade, algo trading, RFQ,

Higher touch approach: involves human interaction large block trades-->urgent principal trade or broker risk trades dealer is the countery party buy/sell from their own inventory if the security is less active, ealer will quote a wider bid-ask spread called quote-driven, OTC large block trades-->non-urgent or v illiquid -->agency trade dealer attempt to arrange trades as a broker attempt a cross-->matching with other client orders then open market --> split order up RFQ-request for quote...PM requests quotes from dealers 2) liquidi standardized securites with order-driven market-->trading done electronically with multiple venues...for trades other than large orders 3) large orders, liquid, standardized-->algo trading high-tough generally inefficient subject to front-running

Investment Policy Key Doc (what is in the objective statement)

IPS Mission-->investment objectives (return target and level of risk)-->within guidelines... SAA designed and implemented for return and level of risk

Qualitative Investment Manager Selection Process: (investment due dilligence and operaitonal due dilligence)

Investment due diligence (philosophy, process, people portfolio)...is the manager expected to continue to generate this return distribution...operational due diligence (process and procedure investment vehicle, terms, monitoring)

LT Care

LT care is designed to cover a portion of the cost of home care/assisted living

Basics University Endowments (endowment spending level and donations)

LT investment portfolios of universities not subject to a specific legally required spending level typically the principal amount of any donation must be preserve in perpetuity

External Constraints for Pension Funds in terms of legal, tax, etc. DC and DB tax exempt or tax deferred?

Legal and regulatory: varies by country...similar themes-->reporting and transparency-->funding requirements-->discount rates Tax & accounting: restrictions on plan design, governance, and investment activities in order to qualify for favorable tax treatment DB: typically tax emeplt DC: typically tax derred

Bank Balance Sheet Approach What are assets and what are liabilities?

Liabilities: deposititors (individual, corp, gov), derivative counterparties, creditors Assets: retail/commercial borrowers

Soveign wealth fund liabilities and investment horizon Budget Stabilization, Development, Savings, Reserve, and Pension Reserve Fund What do each invest in? What is each's time horizon?

Liabilities: not clearly defined usually Budget stabilization: uncertain liabilities (given typically shocks to budget with unknown magnitude). relatively short investment horizon...avoid assets that are highly correlated with the main source of government revenue...mainly invest in government bonds Development fund: uncertain liabilties given projects in this fund are yet to be defined in some cases...medium to LT time horizon Savings Fund: long term liabilties and time horizon given they are trying to transfer wealth from generation to generation...risky and illiquid assets but avoid asset highly ocrrelated with the non-renewable resource it is diversifying from Reserve: liabilities are the CBs, monetization stabailization bonds, long time horizon Pension Reserve: liability is future pension related obligations; LT time horizon...accumulatoin phase/decomulation phase...equity AI-->property infrastructure, PE

Insitutinoal Investors LT investment horizon:

Long investment horizon + low liquidity needs (allow for holdings of alt investments) banks/insurance-->perpectual horizon but typically short maturity holdings

High water mark fee

Look to see the positive return following a negative return year

Determine which allocation you should recommend in a MVO using a utility function and justify your response

MVO provides a framework to determine how much to allocate to each asset to create the optimal asset mix. The highest utility is X so choose Y

Lifetime Gratuitous Transfers (also known as Intervivous Transfers) When are they made relative to lifetime of donor?

Made during the lifetime of the donor may or may not be taxed (depends on jurisdiction)

Investment Manager Selection Universe and Factors to Consider (replacing and adding a manager, also discuss what you do with your universe)

Manager universe consists of only those managers who are suitable for the portfolio in terms of the objectives and constraints in the IPS, invest in the relevent style desired by the client, and will manage the portfolio with the appropiate balance btw active vs. passive approaches THE PRocess 1) establish the role for the potential manager within the portfolio and that is defined by the benchmark (ie active v passive) 2) the benchmark can be determined using one or more of: 3rd party categorization, returns based style analysis, holdings-based style analysts, and manager experience 2a) with 3rd party categorization of managers provided by database, the problem is that provider's definition may not be the same as that definitino for hte purposes within the portfolio 2b) manager experience can be ascertained by analyses of holdings within the manager's portfolio as well as past returns 3) at the manager universe stage, there should not be any performance assessment; that will occur later during quant analysis; instead there must be an emphasis on manger's risk profile and whether or not it is a good fit for the portfolio's requirements. Selection universe: Universe is suitability, style, active v. passive (what is the feasible set of managers)... new search/new strategy-->examine a broad universe ...adding a manager within a strategy-->look for a complement to current holdings... replacing a single manager within a strategy-->look for best in that strategy universe focus on initial screening process is on building the universe of managers and should not focus on historical return. Identifying a benchmark is a key componnet of

Quantitative Investment Manager Selection Process (think on attribution/appraisal)

Manager's performance track record...attribution/appraisal

Marginal vs. Effective tax

Marginal is the range where $x actually falls while average is the weighted average in a progressive tax regime

Traditional Portfolio Construction

Mean-variance efficient...the optimal portfolio given the investor's risk tolerance

Behavioral Portfolio Construction (what are the 4 approaches)

No single unifying theory (an evolving field)...that said there are 4 behavioral models: Behavioral approach to consumption and savings, behevahiora approach to asset pricing, behavioral portfolio theory (BPT), Apdative market hyothesis

Bayes Formula

P (U1|R) = (P(R|U1)/P(R)) * P(U1) where `

Misfit active return

P return - investor benchmark misspecification can lead to mismeasurement of the value added the normal portfolio/benchmark most closely represents the mangager's typical positions in his investment universe

True Active Return

P return - normal portfolio/benchmark

Scheduled Algos are appropiate for

PM has no expectations of momentum (adverse price moves) PM has greater risk tolerance for longer execution time period minimizing market impact relatively small order size (5-10% of expected volume) relatively liquid or balanced buy/sell orders

Price target benchmarks

PMs seeking ST alpha purchase shares at or below some target price

Economic balance sheet

PV(all available marketable and non marketable assets) - PV(all current + implied liabities) = economic net worth allocation of different asset types changes over the life cycle 2 individuals with the same net worth may not have the same net wealth...i.e. should invest differently

Planned Client Goals

Planned goals: can be reasonably estimated or quantified within an expected time horizon ex. retirement specific purchases (functino of wealth and stage of life) education family events wleath transfer philanthropy

Investment objectives of a private foundation (primary and secondary)

Primary: generate a total real return of 5% (inflation = CPI) plus investment expense with vol (10-15%) over a 3-5yr period...real return + investement expense + CPI = nominal return secondary: outperform the policy bencharmket within same specified tracking error

Investment Objectives for a bank (primary objective, who sets IPS)

Primary: manage bank's liquidity and risk position rlative to non-securities assets, derivative positions, liabilities, and shareholder capitalization asset/liab mgmt. committee-->sets the IPS has the ability to mandate adjustments on the Asset or Liability side of the B/S

What are private client investment concerns vs. institutional clients concerns: Investment Objectives

Private Clients: 1) financial security during retirement, 2) provide finacial support to family members, 3) philanthropic goals...may not be clearly defined or quantified...may compete with one another...may change over time Institutional Clients: 1) more clearly defined objectives (typically related to a spanding or liability stream), 2) unlikely to change materially over time

Human Capital what is the formula how big is the asset on an economic b/s what discount rate should be used interplay on how being laid off effects human and financial capital

Prob of surving to year t * income from employment * (1+ annual wage growth) / (1 + rfr + risk premium associated with income vol) laid off effects both human and financial capital PV of future earnings and wages often the dominant asset on a household economc balance sheet some professions will recieve higher wages and some will be more sensitive to the business cycle the discount used should be consistent with the risk of wage growth and consistency

What types of sensitivity anlaysis can be evalauted with a multi period Liabiliy Relative Asset Allocation

Provide estimates of the prob of meeting future obligations and the distribution of outcomes, several types of senstivity anlaysis are likely to be performed: for example expected returns could be increased/decreased to evaluate the impact on future contributions to the plan likewise by anlayzing historical events, the investor can est the size of losses during crash periods and make decisions about the best asset allocation to protect against these worst case events. multiple risk measures over time (temporal risk measures) can be readily included in simulation system

Deemed Disposition What is it? What kind of tax is paid on it?

Rather than an estate or inheritance tax, some jurisdictions used deemed disposition estate pays tax on any unrealized cap gains (i.e. the estate is deemed to have disposed of the assets at current market values)

Risk attribution for top-down on relative and absolute measures

Relative: attribute tracking risk to relative allocation and selection decision Absolute: factors marginal contribution to total risk and specific risk

Risk attribution for bottom-up on relative and absolute measures

Relative: position's marginal contribution to tracking risk Absolute: positions marginal contribution to total risks

Returns based benchmarks

Rp= bo + b1*style1 + b2 *style2+ etc.

What part of the bank equation does holdings a more liquidi of portfolio impact

SD assets go down

Asset allocation Private Foundations (small endowments have high/low allocations in what)

Smaller size--> lower AI and higher US equity Largest: very low FI allocation Generally private has more AI than community recall foundations support an entire budget, universities have other finacning sources...foundations are mandated to payout 5% of aum to remain tax exemplt...tax-emempt (no further gifts or donations can be add ot the fund)

Taxation on wealth and wealth transfers What do you get taxed on for source taxation and what do you get taxed on for residence taxation?

Source: tax wealth economically sourced in the country residence: tax worldwide wealth wealth transfers depends on a) donor country, b receipents conutry, c) location of asset

Market Overviews: OTC Derivatives (urgency, size principal and agency)

Spot FX trades take place in OTC markets that use both electronic trading and high touch broker Large urgent trades, RFQs are using with brokers For large non-urgent trades, schedule algos or high touch agency approaches are used The market is 3 tiers with interdealer, interbank, and bank to client with decreasing trade sizes and increasing spreads respectively per each

Primary Capital in Goals based asset allocation what is the sum

Sum of the personal and market risk buckets

ST Shifts in TAA (taxes/transaction costs, concentration risk, and 2 types of TAA)

TAA incurs additional costs (trading and taxes)... TAA may also increase concentration risk... 2 Broad Approaches: 1) discretionary TAA (Based on manager skill in predicting and timing ST market moves), 2) systematic TAA: based on technical analysis/market signals...look for asset class level return anomalies (value, momentum, valuation, trend-following)

Taxation Regimes

Tax structures are on a national, regional, and local level

Insurer External Constraints (Standard Fin acccounts, statutory accounting, and true economic accountings)

Tax/accounting: 1) standard fin accountings: IFRS and GAAP 2) Statutory accounting: imposed by regulators...subtraction of intangible assets, accelerations of certain expenses, recognition of additional reserves...results in lower earnings, lower equity capital 3) true economic accounts: market to market all A/L; results in most volatile earnings Bank and insurance companies are taxable

Investment horizon for banks

The investment horizon for a bank portfolio is influenced by the difference between the longterm illiquid assets and the short-term liquid liabilities of the bank. Although banks are perpetual organizations, the instruments held in the investment portfolio of a bank are likely to be very short in nature, such that the bank can manage the volatility of shareholder capital on a medium- to short-term basis. perpetual life BUT ST to MT maturity for some assets/liabities

Norway Model (what is it and the positive and negatives associated with it)

Traditional style, 60/40 equity/fi allocation, v few AI, largely passive, tight error tracking limits Positives: low cost, transparent, suitable for large scale easy to understand Cons: limited value-added potential

Behavioral Finance Traditional Finance vs. Behavioral Finace (assumptions on rationality)

Traditional: normative (ideal)...grounded in neoclassical economics where individuals are 1) risk averse, 2) self-interested, 3) utility maximizers (all considered rational behavior)...belief that markets are efficient where prices incorporate and reflect all information Behaviorial is descriptive (actual based on observed individual and market behaviors). Grounded in psychology...neither assumes rationality nor efficient markets...specifically looks at biases/errors that impact financial decisions

Testamentary Gratuitous Transfers when are the made wrt lifetime of the donor? who pays the taxes?

Transfers made after death taxes maybe applied to the tranferor (wealth transfer tax) or the receipient (inheritance tax) May be a flat or progressive tax may be a threshold allowance

Trust Control do the beneficiaries control the trust?

Trusts make resources available to a beneficary without yielding complete control over the resources

Asset-based benchmarks (Properties of a valid benchmark)

Unambiguous: securities/weights clearly identified investable: possible to replicate and hold the benchmark to earn its return measurable: on a reasonably frequent and timely basis appropiate: consistent with the PMs style or area of exerptise reflective of current investment opinions: managers should be familiar with constituent securities specified in advance: constructed prior to evaluation period accountable: manager should accept it

Would adding a position/subportfolio with a higher Sharpe ratio than the aggregate portfolio boost the aggregate's portfolio sharpe ratio

Yes holding all else equal...that said in reality its not often true as diversification potential may differ (ie. the high sharpe subportfolio may be highly correlated with the total portfolio. Also other risks should be considered like funded status and VAR

Benchmarks

a collection of securities that represents the pool of assets available to the PM should reflect the investment process and the constraints that govern the constructino of the portfolio

Life Insurance Uses taxes, hedge, liquidity

a hedge aginst the risk of premature death of an earner can also provide liquidity to a beneficiary without the delay of probate (fund the probate process, cover estate tax on illiquid assets) may also be used as a tax-sheltered savings instrument (US)

Absolute Return Benchmarks

a min target return...not investable, do not satisfy benchmark criteria

Hedging puts, cashless colar, prepaid variable fwd, mismatch of character

a) Purchase puts: lock in a floor price, retain upside potential, defer capital gains tax (no exercise)...retain dividends and voting rights b) cashless (zero-premium collars): lock in a floor price; retain limited upside potential...if no exercise, defer capital gains tax...retain dividends and voting rights c) prepaid variable forwards: a collar to hedge and a margin loan on the position combined in one instrument...an agreement to sell a security at a specific time in the future with # of shares varying with the underlying share price at maturity tax characteristics of the instruments being used to hedge can determin the optimal strategy...if the instrument being hedge and the tool that is being used to hedge produce income and loss of a different character--.mismatch in character

Market Inefficiencies can be behavior and structural

a) behavioral: created by actions of other market participants (Temporary)... b) strucutural: created by internal or external rules and regulations (long lived)...other active assumptions concern correlations, intrinsic value, and market price convergence, macroeconomic influences, etc.

Questions for the managers

a) can the manager clearly and consistently articulate their investment philosophy? B) are the assumptions credible and consistent? C) how has the philosophy developed over time? D) are the return sources linked to credible and consistent inefficnences? E) does the investment team have sufficient expertise and experience? F) do the have succifienct depth? G) how positions are implements?, how are allocations set and adjusted, are allocations consistent with conviction, how has growthin AUM affected portfolio characteristics, what ypes of securities are used? How are long and short ideas expressed (paired or independent), what levels of liquidity are maintained?,

What are the client objectives and concerns across public traded stocks, private businesses, and real estate talk about control, family considerations, business operations

a) publicly traded stock (holding may be a requirement, may wish to maintain effective voting control) risk retention vs. risk reduction b) private business: too early to sell, may wish to maintain total control, may wish to keep the business in the family c) real estate: may be necessary as part of a larger business, may wish to keep in the family may not always be appropiate to reduce or eliminate concentration risk

Soft Skills: social skills

abaility to understand and relate to others empathy

Capital Market Limitations Discuss box trades and share liquidity

ability to borrow shares (box traders and dealer hedging) liquidity of the shares (adjusting hedges)

Soft Skills

ability to effectively interaction with others

Risk attribution on an absolute and relative basis

absolute mandates: identified sources of vol benchmark relative: identified the sources of tracking risk

Goals based (what is the objective)

achieve goals with specified required prob of success

Pension Return Objectives (funding objective, LT target rate, what should the return requirement be?, can objectives differ for the active lives portion vs. retired lives?)

achieve returns that adequately fund its pension obligation on an inflation-adj basis achieve a LT rate of return on plan assets that exceeds the assume discount rate return requirement= discount rate used to calc PV liabiliteis return objective may be related to: a) future pension contributions-->make future contributions=0 b) pension income--> maintain or increase pension income (a well funded plan can generate negative expense) note: objectives may differ for the active lives portion vs. the retired lives

Soft Skills: communication

active listening, effective verbal and written communictation skills, presentation skills

Portfolio Review talk about plan reveiew, objective, risk tolerance, time horizon, circumstances, asset allocaiton

actual meeting with client--> review the investment plan, ask about changes in investment objectives, risk tolerance, time horizon, curcumstances, comparisons of asset allocation vs. targets

Assets under Management Fee (ad valorem fee)

ad valorem fee: related to ability to attract and retain capital and increase asset value

Safety Reserve what does it add to? does it provide a cushion and how to it relate to spending needs?

adds to core capital estimate to incorporate the risk of asset underperofmrance provides a capital cushion if capital markets produce a sequence of poor returns (uncertainity of capital markets) Allows spending beyond that articulated in the spending needs (uncertainity of future commitments)

Market-adjusted cost:

adjusts for general market movement

Trade strategy inputs (think in terms of urgency, costs, and risk)

affect trade urgency, expected costs, and risks of the trade

4) Process used to monitor execution arragements (trade governance)

all brokers and execution venues used should be subject to ongoing monitoring for reputational risk, irregularities, criminal actions, and financial stability...use of a best execution monitoring committee...firm wide responbility for trade execution monitoring...trading records stored and accessible for several years

Residence Jurisdiction is this most common? is all income subject to be taxed on this? Who is typically exempt?

all income (foreign and domestic) is subject to taxation (worldwide income) most common typically noncitizen residents, resident citizens, but not non-resident citizens no international standrarized residency test (residency thresholds differ btw countries)

Perfect Information

all investors know all things at all times...will always make the best decisions

Estate definition

all of the property a person owns or controls

Strong-form

all public and private info is fully reflected in prices...inside info will not generate excess return

Return attribution

analyzes the impact of active investment decision on returns

Bubles and Crashes (behavioral explanations

appear to be panics of buying and selling... more objectively when a price index for an asset class trades more than 2 SD outside its historic trend... behavioral explanation: overconfidence (ie overtrading, underestimation of risk, failure to diversify, rejection of contradictory info), confirmation bias (selling winners confirms the success of their strat), self-attribution bias, regret aversion (not wanting to miss out), illusion of knowledge (noise trading increases in bubles may be takes as relevant info)

Single Asset Concentration talk about cost basis talk about why they need to monetize the asset?

as the owner of a concentrated position, the asset may need to be sold or monetized (either to fund retirement or for risk management) yypically a position that has been helf dor a long period of time iwth a low cost basis relative to current market values

Usefulness of Capture Rates

assessing consistency btw stated invesment process and reported performance capture ratio of 1 indicates that there are symmetrical return profile capture rate >1 is positively asymmetircal (convex) capture ratio <1 is negatively asymmetrical (concave) REMEMBER IT IS UPSIDE CAPTURE/DOWNSIDE CAPTURE = CAPTURE RATIO!!!!!

Traditional Balance Sheet early life cycle stages net worth is expected to be what while human capital is expected to be what?

assets - liabilities = net worth for individuals in the eaerly life cylce stages, net worth may be negative but human capital may be large traditiona lS ignores these

sample size neglect (Representativeness Bias):

assume small samples are representative of populations

Investment Due Diligence

attempt to assess the repeatability and consistency of the investment process Don't invest in things that have 0 marginal return or arent' repeatable

Financial Capital (Personal Assets)

autos, clothes, furniture, etc. not expected to increase in value derive personal worth from their value-in-use

In the events of underperofmrnace (fees):

base fee still paid

Foundations How are the different from a trust? Why chose a trust or a foundation?

based in civil law countries and unlike a trust is a legal person choice of trust or foundation usually an issue of jurisdiction

Cognitive Errors (Individual BFMI):

basic statistical, information processing, memory errors

behavioral biases and investment policy/asset allocation

behavioral biases can and should be accounted for in the investment policy developement and asset allocation selection process

Benchmarking Managed Derivatives

benchmarks typically specific to a single investment strategy

Cognitive Error (what is it and is it easier or harder to correct?)

biases based on faulty cognitive reasoning...stem from basic statistical, information-processing or memory errors...cognitive errors are more easily corrected than emotional biases (better information, education, advice)

Holdings based style analysis (approach, time horizon, comparability, window dressing, computational effort,

bottom-up approach... classifies the actual holdings in a portfolio at a point in time (estimates current risk factors)... Typically easier for equity strats. If a comparable across managers and through time...subject to wondow dressing... more complex strategies increase the computational effort... requires manager transparency.. .may not reflect the portfolio going forward particularly for high turnover startgies

Insurer Liabilities and investment horizon (Life/LT liabilities, annuitiies, proporty and causalty) Life/LT Liabilities (time horizon) annuities/ongoing payouts: (time horizon) Property/causalty: (time horizon)

business line determines the nature and structure of liabilities liabities are identfied with their predictability Life/LT Liabilities have high predictability using actuarial analysis on large portfolios, one-time payout, subject to mortality risk...investment horizon is LT (20-40yrs perpetual life however) annuities/ongoing payouts: shorter duration, subject to longevity risk Property/causalty: shorter duration liability stream, higher uncertainty...investment horizon--> Shorter than life (perpetual life hoever)

Zero-premium collar

buying puts and selling calls on shares to be hedged

Lifetime gifts (Taxable) how gets the gift does the original holder have taxes? do they still hold assets?

can also gift assets with higher expected returns to second generation, first fneration hold assets with lower expected returns (lowers estate tax)

FIxed Income Attribution (yield curve decomposition...duration based)

can be either top-down or bottom-up estimates the returns based on duration %total return = %income return + %Price change (which is -modDur * change in yield) applied to both the portfolio and the benchmark difference = effect of active PM decisions requires more data points than exposure decomp typically used in reports for analysts and PMs

Reference Prices (price benchmarks) what is it used for

can be specified prices, price-based calculations or price targets used in calculating actual trade costs for post-trade evaluation

Tax Treaties

can exist btw countries with tax relief specified as credit, exemption or deduction

Capital Sufficiency Analysis:

capital needs analysis process to determine if a client has or is likely to accumulate sufficient financial resources to meet objectives

Cash values and policy reserves along with when does insurance become unnessary What is the role of insurance and is it necessary after you retire?

cash can accumulate within the policy can be withdrawn by the policy owner when the policy endows (maturies) or when policy is terminated can be borrowed against Premium stays constant, face value stays constant, cash value increases, insurance value decreases...since insurance is meant to replace human capital, may become unnessary after policy holders working years are over Policy Reserves: insurance company liability. represents the future payment to be made. policy reserves increase to the face value over time.

base rate neglect (Representativeness Bias):

categorization without considering the prob

Altruism

challenges perfect self interest

IPS

changes in investor's curcumstances asset owner's objectives and constraints changes IPS

Forced Heirship Rules chilrend and spouse considerations forced heirship in civil law countries how to avoid forced heirship

children have the right to a fixed share of a parents estate (spouses as well) Forced heirship in civil law countries may reduce or eliminate the need for a will. Individuals can attempt to reduce or avoid forced heirship by: 1) moving assets into offshore trust governed by a different jurisdication, gifting or donating assets to others during their lifetime to reduce the value of the final estate upong death, 3) purchasing life insurance which can move assets outside of realm of forced heirship provisions

Bounded Rationality

choices may be rational but are subject to the limitations of knowledge and cognitive capacity (challenges perfect information)

Personality Types

classify investors by their psychographic characteristics: assumptions those fitting specific psychographic profiles are more likely to exhibit specific investor biases...

WML

close to 0 then no momo

low tracking risk and low active share

closet indexer

Protective Put what are the two downsides for a protective put

combining a long stock and a long put which would provide downside protection (lock in a floor price) with unlimited upside downsides include 1) out of pocket expense to buy puts and 2) counterparty risk

common vs. civil law systems compare and contrast common and civil laws

common law: testator usually has the freedom of disposition (the right to use their own judgement regarding property). Law is primarily developed through decisions of the courts. Civil law: restrictions on such dispositions. law developed primarily through legislation

Tax considerations for concentrated positinos what is the primary tax goal for concentrated positions

concentrated postions are often highly appreciated versus their original costs significant embedded capital gains tax liab deferring or eliminating the tax is a primary objective

high traking risk and high active share

concentrated stock picker

Trust and common law Does civil law recognize a trust?

concept of a trust is unique to common law (may not be recognized in a cival law jurisdiction)

Economic B/S:

conventional assets + liabs plus extended portfolio assets and liabs (PV Human Capital is 30% equity like and 70% bond like but depends on industry

Non-tax considerations (Public Traded Shares) think fees, counterparty, size constraints

counterparty credit risk ability to close out a transaction prior to stated expiration price discvoery transparency of fees flexibility minimum size constraints

Source Jurisdiction discuss country taxing income

country taxes income as a source within its borders (also called a territorial tax system)

Comprehensive major medical insurance

covers the vast majority of health care expenses

Tax evasion what is the definition

curcumventing tax obligations by illegal means by misreprensenting/not reporting inofmration

Store of value:

currencies, gold, art

Endowment Stakeholders

current and future students alumni-->typically the donors (general or restricted support) current and future faculty/admins (payouts support operating budget)

Individual RIsk Exposures: property risk think hurricance damage

damaged,destroyed, stolen, lost

Equity Attribution (Factor Based)

decompose contributions to excess returns from factors

What part of the bank equation does diversifying insurance business impact

decrease SD L Total insurance liabilities are less uncertain.

What part of the bank equation does surrender penalities impact

decrease SD liabilities Penalties cushion losses when policyholders cash in after interest rates have risen.

What part of the bank equation does holding HQ bond/debt investments impact

decrease vol in assets

What part of the bank equation does holding diversified fixed income impact

decrease vol in assets

What part of the bank equation does predictabiity of underwriting losses impact

decreases SD L Total insurance liabilities are less uncertain.

What part of the bank equation does derivatives transparancy collaterlization impact

decreases both SD asset and SD liab whine increase p The more understood and protected against counterparty default the institution is, the less chance there is of unexpected losses.

Health/Medical Insurance overview

depends on the country may be public-paid by tax dollars may be private (US or a combo

Pension funds background (what are the two ways pensions provide for retirees)

designed to provide for the financial needs of retirees through two ways: defined benefits or defined contribution

Performance Based Fees

determined by portfolio retruns...structured in 3 ways: a symmetrical structure in which the manager is fully exposed to both the downside and upside (compted fee= base + sharing of performance)... 2) bonus structure with downside limited but no upside limit: computed fee= higher of base or base + upside, 3) bonus in which downside and upside are limited but no symmetrical (computed fee is higher of the base and base + upside limit)

Market Behavior: 1) market anomalies:

deviations from market efficienty...persistent abnormal returns that differ from zero and are predictable in direction BUT anomalous behavior may just be a result of the asset price model used...some anomalies may be explained by small samples statical bias (selection or survivorship) or data minimg...anomaly may be temporary...may be attributed to rational behavior not captured by pricing models (tax loss selling)...behavioral considerations...emotional biases most likely no good conclusions...2) momentum (or trending effects): future price behavior correlates with that of the recent past (up to 2 yrs)2-5yr returns typically revert to the mean...herdingwhen a group of investors trade on the same side of the market in the same securities...reflects a low dispersion of opinion about the interpretation of information...explanation: short term underreactino to relevant info and LT overreaction...ST underreaction: disposition effect (selling winders) and achoring (treating past price as intrinsic value irrespective of news)...LT overreaction: availability bias or recency effect: extrapolate recent past price increase to the future...regret: driven to buy recent winners not owned

Liquidity

different vehicles provide different degrees of liquidity...most liquid are closed end funds, etfs (listed securities)...open ended are slightly less liquidi (daily liquidity at closing NAV)...limited parternships have limited to no liquidity

Valuation Discounts does illiquidity or lack of control impact transfer tax? How do you create illiquiidty or lack of control?

discounts for illiquidity and lack of control transferring assets subject to valuation discounts reduces the basis on which transfer tax is calculated can intentinoally create illiquidity and lack of control by placing assets in a family limited partnerhip transfer minority interest

Institutinoal Investor very large >$10b -->

diseconomies of scale...unable to access niche investments (VC/PE, small cap growth, etc.) typically pushed into private assets, infrastructure assets

low tracking risk and high active share

diviersified stock picker

Factor Based approaches (correlation)

do not use asset classes as the basis for portfolio construction not better, just different focus on assigning investments to the investor's desired exposures to specified risk factors overlap in risk factors explain the correlation of equity and credit markets asset class allocation obscures the portfolios sensitivity to overlapping risk factors

Market Conditions (in terms of vol and liquidity) What happens to vol and liquidity in market events Relationship btw market liquidity and trading horizon Relationship btw vol and trade urgency Relationship btw trading horizon and execution/market risk

during market events or crisises--> vol increases and liquidity decreases security liquidity will change because of changes in market liquidity lower market liquidity-->longer trading horizon but higher vol may heighted trade urgency longer trading horizons increase execution/market risk

Real Estate (charitable donation)

earn an income deduction if the property is then sold inside charitable structure, no tax event is triggered so donate--> then sell

How to find efficient frontiers on the MVO graphs

edges

Benchmarking Hedge Funds

encompass a broad range of possible strategies may have an unlimited investment universe difficult to create a single standard broad market indexes are unsuitable as benchmarks rfr+spread is sometimes used fund manager universe may be used as a benchmark unlikely to be representative of any single fund suffer from survirorship and backfill bias HF performance is self-report and not confirmed by the index

1/n rule:

equally weighting allocations to assets...1/n of wealth is allocated to N asset classes...empiraical studies show 1/n rule performs considerable better than theory might suggest

Estimating core capital with monte carlo

estimate the amount of capital required to sustain a pattern of spending over a paritcular time horizon with a 95% probability i.e. determine core capital that sustains spending in at least 95% of trials; safety reserve may also be added, but would be smaller than mortality tuble method

SAA

evaluate process and compliance with IPS via results and that feedback changes SAA

Market Overviews: Equities (where its traded, how its traded, small vs. large trades)

exchanges (lit markets) and dark pools (ATS or MTF-multilateral trading facilities) most trades are electronic, algo trading is common large and urgent trades-->high touch (esp illiquid securities) large and non-urgent->traded algos small trades-->electronic trading

Risk attribution for factor-based on relative and absolute measures

factors marginal contribution to tracking risk and active specfic risk

tax-free gifts:

fall below periodic or lifetime allowances

Single asset conceptration (private stock) who owns it?

family (generational) or new venture

copayments

fixed payments policyholder must make for particular services

Real Estate (mortgage financing) if mortgage is non-recourse who holds the downside how do you monetize the a real estate asset it will only work when?

fixed rate mortgage where interest and principal repayment = NOI of the property monetize the LTV amount, invest in diversified asset portoflio only works if the property in held name (inside a corporattion-most common-would entail a loan to shareholder) must carry market rates of interest and be paid back if the value of the property increases over time, owner holds the upside if the mortgage is non-recourse (rare in commercial lending), lender holds the downside

Liability Based Benchmarks

focus on the cash flows the assets must generate track a fund's progress torwards fully funded status or track the performance of assets relative to the changes in liabilities characteristics of the liabilities influence the composition of the asset portfolio trying to close the gap between assets and liab. The perfromance is judged relative to the objective used for a total fun portfolio (including equities) as the plan tracks its funded status

Foundation stakeholders

founding family donors grant receipients broder community

Liability Relative (what is the objective)

fund liab and invest excess assets for growth

Technical Skills: Capital Market Proficiency

generalist understanding of the markets and asset classes

Goals Based (SAA):

generally set the strategic asset allocation in a bottom-up fashion 1) Brunel: personal goals, dynastic goals, philanthropic goal 2) chhabra: personal risk bucket, market risk bucket, aspirational risk bucket the higher the prob requirement for a future cash flow need, the greater the amount of assets needed in relation to it. Discount rates could be set a low levels so that assets are assigned to critical sub-portfolios (increases prob of achieving the goal) BUT sub-portfolio add complexity...goals may be ambiguous or may change over time

Bayes

given new information, decision maker is assumed to update beliefs about probabilities

Major asset classes:

global public equity (developed and emerging); global private equity (VC/PE), global fixed income (developed and emerging), real estates (provide snesitiy to inflation)... as more and more sub-classes are defined, they become less distractive

What is the roal of a wealth manager (state the three things)

goal quantification goal prioritization goal changes

Personal Risk Bucket what is the goal what is the allocation you should have in it?

goal: protection from poverty or dramtic decrease in lifestyle allocations: yield below market return, safe investments, home, CD, T-Bills

Aspiration risk bucket what is the goal what allocaiton should you have in it?

goal: the opportunity to increase wealth substantially allocations: yeild above market returns with substantial risk of loss of capital (concentrated position) Goal is to support primary capital and provide surplus capital

Trade Governance 4 Trade policy areas

good practice and usually required by regulation that an asset manager has a formal written trade policy that clearly spells out trade procedures. typically has 4 policy areas: 1) best execution, factors that determine the optimal trading approach, 3) listing of approved brokers and execution venues, and 4) details monitoring proceses used by the asset manager all asset managers should have a trade policy document that articulates the firms trading policy...mandated by major market regulator...purpose of the policy is to ensure execution and order-handling procedures are in line with the duty of best execution owed to clients

Foundations basics (gifts and investment assets)

grant making institutions funded by gifts and investmetn assets

60/40 portfolios

greater emphasis toward growth. could be used to fund goals that need to have high prob of success

Committee Decision Making:

group process may mitigate individual biases or exacerbate them...may also create additional biases: social proof bias: individuals are biased to follow the beliefs of a group... may moderate personal views to fit in with the consensus...may feel pressure to agree with views expressedby powerful individuals... assemble diverse group with relevant skills/experience...create a culture tolerant of dissenting views... chair must play a pro-active role (chair can collect individual views in advice of discussion) while members actively contribute

Strategies

hedge funds

Endowment Model (what is it and pros/cons)

high AI exposure, active mgmt., outsourcing suitable for: LT investment horizon, low liquidity needs, skill in sourcing AI Positives: high value-added potential Cons: Expensive, difficult to implement for a v large funds/small funds

Individual Risk aversion (does an individual with greater market risk trade with more urgency)

high level of risk aversion, more concern about market risk, trade with greater urgency

Decreasing the bands

higher correlation

HIFO Accounting when lots are purchased which one do you select to sell first?

highest-in, first-out tax lot accounting typically not very common when lots are purchased at different prices, select those purchased at the highest price for first sale when the current year tax rate is low, may be worth letting the loss remain unrealized if tax rates willbe higher next period

Surplus value, funding ratio

highly dependent on the discount rate

How to lower Da simply think what is a bank's asset and what will lower or increase duration

hold cash, deposits at CB, foreign reserves, or other zero duration assets make business loans with floating rates credit card balances, real estate loans-adj rates fixed rate mortgages-->securtized and sold off

Trusts What is it? What is an revocable trust? Does it have creditor pretection. Who owns the assets? What is an Irrevocable trust? Does it have creditor pretection? Who pays the taxes? Who owns the assets? Do you use a will or transfer doc for trusts? What about probate?

holds and manages the assets of a settlor for the benefit of the beneficories Revocable Trust: 1) settlor retains right to rescind trust, regain ownership of assets 2) settlor is owner of assets for tax purposes 3) no creditor protection Irrevocable Trust: 1) creditor protection, 2) trustee pays taxes, 3) trust is the legal owner of the assets both forms bypass probate transfer of assets dictated by the trust document and not the will

Net Wealth (economic net worth) what is the formula

human capital + investment assets + PV future pension benefits - liabilities - PV future consumption needs

Advanced Life Deferred Annuitieis when do payments begin what is it used for

hybrid btw deferred and immediate fixed annuity payments being 80-85yrs would provide the greatest supplemental level income (not health related) relative to the cost because the payments are made far in the future, life expectancy is shorter when payments begin, and some policyholders will die without recieving payments

Philosphy developing over time

ideally it is unchanged through time-->changes should reflect chaing market conditions vs. reactions to performance

Critquing the efficient asset mixes on graphs

if # of edges is less than number of available asset classes for the portfolio then a critisms is that they are concnetrated in only a subset of asset classes which likely reflects the input sensitivity to MVO

Exit Taxation what is it typically applied to?

if applicable, applies to unrealized gains (i.e. deemed disposition)

Benchmarking distressed securities

illiquid and non-marketable...difficult to create an index

Terms of the investment

in the prospecturs, private placement memorandum and or limited partnership agreement...these documents are the contract between the investor and the manager

Tax Reduction and Trust How is income generated by trust assests taxed? Does it impact your income tax?

income generated by trust assets may be taxed at a lower rate lower progressive tax bracket set up trust in low tax jurisdiction assets may be transferred to a trust for estate tax purposes but no income tax purposes (income may remain taxable to the setlor)

What part of the bank equation does castastropic insurance risk impact

increase SD liab Such losses are large and unpredictable and will cause regulators to demand higher reserves, investment in more liquid assets, and more robust reinsurance agreements.

What part of the bank equation does holding common stock impact

increase asset vol while decreasing P

What part of the bank equation does maintaining balnce btw asset and liability duration impact

increase p

What part of the bank equation does prepayment penalties on debt investments impact

increase p Prepayments will occur in a low interest rate environment. Penalties on prepayments help offset rising liabilities in a falling rate environment.

What part of the bank equation does variable annuities impact

increase p, and SD A, SD L diminish in relevance Asset investment gains and losses are passed through to policyholders due to the nature of the contract.

Residence-source conflict what is it? how common is it? is it difficult to avoid in tax planning?

individual in country A subject to residence jurisdiction, assets in Country b subject to source jurisdiction-> most common source of double taxxation, most difficult to avoid with tax planning

FIxed Income Attribution (yield curve decomposition...full repricing)

instead of using estimates, prices out each security...most complex attribution of the three

5) Pincipal-agent issues:

interest not aligned...agents may be internal or external...ei. high base fee regardless of performance...manged through highly developed governance models, high levels of accountability

High touch trading

involve high levels of human involvement this is usually required for large trades (known as block trades) since finding the other side to larger trades is more difficult or less liquid markets high touch approaches include: principal trades (also called broker risk trades) and agency trades

Electronic Trading

involves trading via computer and is used in omre liquid markets. Trading here is typically order driven in that electronic systems allow buyers and sellers to advertise their limit orders in a central limit order book. A limit order is an order to trade at a certain (limit) price or better.

Asset Protection Do irrovolcable and discretionary trusts protect assets from creditors? if so what are the differences?

irrevolcable trusts protect assets of the settlor from creditors discretionary trusts protect assets from claims of creditors against beneficiaries

Preferred Provider Plan talk about networks and costs

is a large network of physicans and other medial service providers that charge lower prices to indivudals within the plan than indivuals who obtain care on their own

algo trading

is the use of programmed rules to electronically trade others, primarily used for two purposes: profit seeking and trade execution

Pre-trade benchmarks (decision price, previous close, opening price, arrival price)

known before the start of the trade a) decision price: security price at the time the PM made the decision to buy/sell the security b) previous close: ofent specified by quant PMs c) opening price: used by PMs who trade frmo the open (not "on the open" as the trade itself will affect the opening price) used as the decision price by fundamental PMs opening price does not have overnight risk (all subsequent events are priced into the opening price) d) arrival price: price of the security at the time the order is entered into the market for execution typically used by short-term alpha traders...goal is to transact at or close to currnt market prices

Benchmarking AI

lack of investible market indexes frequent use of leverage limited liquidity lack of readily availble market values use of IRR vs. TWRR

Dark strategies

large orders in illiquid markets and arrival price or scheduled algos would likely lead to high market impact

Agency trades

large trades in illiquid securities that are less urgent Principal trades are high touch (needing human involvement and thus are dealing with illiquid securities) Less urgent as the PM/trader are willing to wait for the broker to find ppl

Principal Trades

large urgen trades in illiquid securities. Principal trades are high touch (needing human involvement and thus are dealing with illiquid securities) Broker takes ownership of security so it is URGENT

Liquidity Seeking Algs

larger orders in less liquid electronic markets with higher urgency, or when liquidity is sporadic high urgency as they are trying to get liquidity and typically larger orders

Private Equity/VC

least liquidity...investors are contractually obligated to contribute committed capital and wait for distributions (10-12yrs period)

External constraints for foundations (legal and regulatory)...what type of return basis do they invest in

legal and regulatory: typically 1) invest on a total return basis and 2) exercise a duty of care when making investment decisions

Individual RIsk Exposures: liability risk think legal

legal liability for property damage or physical injury...needing legal defense by association

Institutional Investors regulatory framework:

legal, regulatory, tax, accounting (differ by national jurisidction)...key drivers: investor portection, safety/soundness of fin institutinos, integrity of fin markets

What is a liability return

liability return measure the time vlaue of money for liab plus any expected changes in the discount rate over the planning horizon

Insurance and estate liquidity think heir seperation

life insurance policy can provide liquidity without the delay involved in the legal battle of settling the estate...this liquidity can be particularly valuable if the estate contains illiquid assets or assets that are difficult to seperate and distribute among heirs

Monetization Strategies (Public Traded Shares) talk about what elon does

loan against the value, re-invest funds elsewhere

Asset location and wealth transfers talk about directing to trusts and estate tax freezes impacting this?

locate the asset in a way that minimizes wealth transfer tax before the concentrated position has appreciated greatly: direct gifts to family or trusts; estate tax freeze (transfer-future appreciation)...requires a corporation or partnership

If given a portfolio, how to determine what would be most concerning

look for concentratoin risk (ie if everything PA virtually all stock not good)

Property Insurance types (Homeowner and Auto)

manage property risk a) Homeowner policy: risks associated with personal property and liability...all risks vs. named risks...replacement cost vs. actual cash value...deductibles (higher = lower premiums)... underinsured = lower payouts b) auto insurance: collision vs. comprehensive. deductibles. often mandatory

Spousal Exemption do spouses get taxed if they recieve a piece of the estate?

many jurisdictions with estate or inheritance taxes allow for bequests and gifts to spouses without tax liability if the value of the estate is below some exclusion threshold, estate can pass without inheritance tax

What are institutinoal constraints for concentrated positions talk about margin lending, laws, lock-ups

margin-lending rules: rules-based vs. risk based (aka portfolio margining) ex. large public stock position with a restiction on sale; buy puts on the position, risk-based margining makes almost 100% of strike price available for diversifiction Securities laws and regulation may be restrictions on timing and volume of sales or hedging transactions (company insiders and executives) Contractual restrictions and employer mandates: e. IPO lockup periods and blackout periods (public stock); right of first refusal and tag-along/drag-along (private stock)

Utility and Bayers Formula

max PV of Utility subject to a present value budget constraint basic axioms...completeness: well defined preferences ranked...transitivity: a>b, b>c then A>c...independence: a>b a+xc> b+xc;...continuity: a>b, b>c...some a+c~b

Max yearly benefit

max amonut a company will pay in a year

Alt Investment Constraints (HF, Private Debt, Private Equity, Infrastructure, Timberland/Farmland):

may be legal min qualifications that exclude asset owners... level of investment understanding and min investment favor larger asset owners... comingled funds may be reuired for prudent diversification... # of funds available may constraing larger funds

Pension Risk Objectives (relative liabilities and relative contributions)

may be stated in terms of pension surplus vol or in terms of shortfall Relative liabs: funded status of 100% WRT PBO; funded status above some level to avoid reporting a pension liability; funded status above some regulatory threshold relative to contributions: min year to year vol of future contribution payments; min prob of having to make contributions may also state absolute risk objectives

pre-existing condition

may not be covered

what are the types of emotional biases

may only be possible to recognize and adopat to it rather than corrit it (rules and discipline)...low aversion, overconfidence, self-control, status-quo, endowment, and regret aversion

Capture Ratios

measures the PMs participatin in up and down markets

Macro Attribution

measures the effect of the asset owner's (sponsors) choice to deviate from the SAA...also measures the effects of the manager selection and timing

Implementation Short fall

measures total costs associated with implementing the investment-decision

Deductibles

min amount policy holders pay

Economic Balance Sheet definition and relate to life cycle and wealth preservation

more comprehensively represents asset available to fund life cycle consumption and for wealth preservation helps illustate the magnitude of risk exposures for an individual

Common global tax elements talk about cap gains, divis, interest

most are progressive, some flat many have special tax provisions for interest (exemptions, favorable rates, exclusions) Dividends may have special treatment (exemptions, special rates, exlcusions) capital gains/losses may have special rates/provisions( long vs. short term, partial/full exclusion)

Charitable Gratuitous Transfers do you pay taxes on charitable transfers?

most charitable donations are not subject to transfer taxes (quite the opposite--> qualify for tax reductions)

Post-trade benchmarks (strat to min tracking error and closing price)

most common is closing price funds valued at end of day NAV will buy on close to min tracking errors (typically used by index and mutual funds)

Asset allocation universtiy endowments (discuss the FI/alt dynamic)

most large endowments follow the endowment model i.e. larger the endowment, the more alts they go and the smaller the more FI

Benchmarking Private Equity

mostly peer group benchmarks limitations: valuation methodologies may differ fund's IRR depends on timing of gains/losses/cf PME: public market equivalents, based on aggregated cash flow data

Trade strategies (what determines trade strategy)

motivation to trade, risk aversion, trade urgency, order size, market conditions all determine trade strategy

What is the Investment strategy for a bank how do they meet their liabilities?

need is to fund deposits policy claims, derivative payoffs, debtholders...underlying strategy is mainly LDI

If they ask the decision to overwegith or underweight a region contributed positively to performance at the fund level

need to calc allocation effect

Cognitive dissonance

new ifnormation conflicts with previously held beliefs

Weak Form Efficiency

no past price or volume info can be used to generate abnormal returns...technical analysis will not generate excess return...to test see if prices are serially correlated also called techincal anomolies...buy/sell signals

Cash (constraints):

no size contraints

Decision Theory (what are the assumptions)

normative concered with identifying the ideal decision...assumes decision maker is fully informed is able to make quantitative calcs with accuracy and is perfectly rational

Implementation approaches (what are the 4 approaches)

norway, endowment, canada, and LDI

Benchmarking Real Estate

numerous indexes available limitations: based on subsets, not fully representative of the asset classperformance likely to be highly correlated with largest data contrrbutors based on self-report weighting may place more emphasis on most expensive cities and asset types (if weighted by fund or asset value) valuations typically appraisal-based (smoothing) are infrequent and often lag the market benchmark returns may be levered do not reflect high transaction costs

Disability income insurance

offsets the risk of lost earnings ability to phusicaly injury, disease or other impairment defined as 1) inability to perform one's regular occupation 2) inability to perform any occupation for which one is suited by education or experience 3) inability to perform any occupation premium is fixed, policy is written for the health and occupation of the insured available individually and through employer typically have provisions for partial (cannot perform all duties) and residual disability (can perform all duties but at lower income)

Time Horizon:

often defined by future liabilities/goals... as time passes, allocations must reflect shortening horizons... even if risk preferences may not change over time, the nature of the liabity or goal will still affect the allocation... time diversification: lower risk/lower return assets with ST goals/liabilities... higher risk/higher return assets with LT goals/liabilities

Style indexes

often well known, easy to understand, widely available (Value, Growth, etc.)

Life Insurance (whole life policy)

one whole life policy may have lower premiums but faster cash value growth comparison facility by: 1) net payment cost index or 2 ) surrender cost index

Bank liabilities (largest assets; largest liabilities)

originate assets (loans), liabiities/deposits, derviatives, FI securities in the normal course of business largest asset-->loans (>=50%), then debt securities (>=25%) Largest liability-->deposits (>=50% of Total Liabilities)...time deposits (term deposits) eg CDs (specificed duration) and demand deposits...assumed short duration wholesale funding, LT debt (10-15% of TA), securities payable and repos (10-20% of TA)

Will/Testament definition

outlines the rights others will have over one's property after death

Active and passive decisions in index construciton

passive: is a transparent rules-based implementation of the weighting scheme behind the index OR the overall selectoin of the universe active: changing the index weights to favor something which implies you have a beliefe that there is some risk-return adv favoring the thing you changed

Equities (constraints):

passively no size constraint...very large asset owners may be constrained wrt certain active strats/managers

Other Performance Fee Notes

performance fees paid annually... may include highwater marks (HF)... PE, HE, and RE Funds, typically have no limits... low Ra, lower performance fee benefit investors and vice versa benefit HF... Low Managers revenue as a result of only a base fee increases operational risk (big reason why symmetrical fee structures are not popular with managers)... if managers have clients with varying fee structures, may favor clients with performance-based fees... when managers can control the timing of profit realization, may have an incentive to hold on to assets until a profit is earnings... clients may benefit from selling at a loss and invetsing elsewhere... HF managers may have an incentive to return funds if MV<high water mark

Endowment Time Horizon

perpeutal (maintain LT purchasing power)

what are the two types of financial capital think consumable and looking to increase

personal (typically consumed) vs. investment assets (held for their potential ot incease in value)...basically intangible and tangible assets

Liability Insurance where is this added to?

personal umbrella liability insurance policy adds to coverage in auto and home policies for personal liability

Technical Skills: Tech Skills

portfolio optimization software, simulation tools, PM software, etc.

Simon

ppl are not fully rational when making decisions and do not necessarily optimize but rather satisfice ppl have informational, intellectual, and computational limitations

Efficient frontiers and taxes are pre-tax efficient frontiers proxies for after tax ones?

pre-tax efficient frontiers may not be reasonable proxies for after tax efficent frontiers the same asset in different accounts is essentially a distinct asset

Market Overviews: Fixed Income (where its traded, role of dealers, small and large trades with urgency)

primarily OTC, quote-driven sourcing liquidity relies heavily on dealers...exept for OTR US treasuries, bond/interest rate futures large urgent trades-->principal trades lage, non-urgent trades-->agency trades

DC Return Objectives (assets and policy benchmark)

produently grow assets that will support spending needs in retirement outperform policy benchmark or/outperform other DC plans

Remedial Actions:

prompt accurate feedback + rewards for accuracy (thus causing overconfidence to go down)...document a decision and reasons for that judgement (allows accuracy to be assess later plus why it was right or wrong...evaluate previous forecasts (reduces hindsight and self-attribution bias)...Provide at least one counterarguement (reduces overconfidence and confirmatory bias)...min the amount of non-comparable data (reduces impact of bias in mgmt.. reports on analysts)...max the amount of objective data

Liquidity for concentrated positinos (public and private) talk about restrictions or difficulty selling

publically traded stock: may be restrictions on amounts and timing of sales private business and real estate: generlly illiquid

Individual Traditional View (rationality, bias, aversion, interest)

rational, make decision consistent with utility theory, revise expectations consistently with Bayers formula...self-interested, risk-adverse, access to perfect info, process all available information in an unbiased way

Emotional biases (what is it and is it easier or harder to correct?)

reasoning influenced by feelings or emotions...stem from impulse or intuition...emotional biases are best adapted to decisions are made that recognize and adjust for these biases

Hedge funds(redemption frequency, notification period, hard lock, soft lock, gates)

redemption frequency: limits how often an investor can withdraw capital... notification period: how far in advance notice of a redemption must be given...lock-up: period during which there are no redemptions... Hard lock: no redemptions... soft lock: penality on redemption... gates: limit the amount of funds that can be redeemed at one redemption date

LP disadvantaged

reduced flexibility to adjust portfolio allocations, reduced ability to meet unexpected liquidity needs... funds can hold less liquid securities with reduced risk of having to sell at inopportune times... removes investors potential for overreaction during times of market stress

Transferring excess capital

relative after-tax value of a tax-free gift during one's lifetime vs. a bequest

Market Index

represents the perofrmance of a specific security market, market segment, or asset class...might be a benchmark

ERISA and ASC

requires over/underfunded pensions to appear on the B/S

Financial Capital (Mixed Assets) examples of mixed assets

residence, artwork, collectibles aspects of personal and investment asset characteristics

Taxes reduce what

return volatility on v tight conditions...tax exempt accounts investor bears all the risks

3) List of eligble brokers and execution venues (trade governance):

reveleant factors: quality of service, reputation, speed of execution, willing to do principal trades, financial stability, settlement capabilities, cost copmetitivness

Risk Aversion 2

risk evaluation is reference dependent...Depends on the wleath level an dcircumstances of the decision maker

Asset Allocation that a risk neutral investor would select under a mean-var analysis

risk neutral is when risk aversion = 0 so expected utility is = expected return. The efficient allocation that maxes expected return is the one with the highest level of vol (so look on the X axis and whatever one is the highest select that)

Goals Based Only (Risk Concepts):

risk of failing to achieve goalsmax acceptable prob of not achieving a goal...overall port risk=weighted sum of risks associated with each goal

Liability Relative Only (Risk Concepts):

risk of having insufficient assets to pay obligations when due (shortfall risk)...vol of contributions needed to fund liab

Individual RIsk Exposures: health risk think of implications toward human and financial capital

risks and implications associated with illness or injury (individual, family member, children) reduces human capital and may drain financial capital LT care costs of aging parents

Institutinoal Investors large-->

scale benefits given they can access investment and can attract internal asset managers

High tracking risk and low active share

sector rotation

Covered Calls talk about yield enhancement, where strike is

sell call options with a strike price that is above the current price of the stock and in return recieve a premium (yield enhancement) from the sale of the optoins. benefits the owner

Real Estate (sale and lease back) explain tax implicatoins, lease payment vs. interest impacts on income

sell the property and immediately lease it back from the buyer provides 100% of the value of the property funds distributed to owners for diviersification or re-invested back into the business lease payments are now an income deduction vs. just interest payments on a mortgage does trigger a tax event

disposition effect

selling winners too soon and holding losers too long (ALSO CALLED LOSS AVERSION BIAS)

Liquidity Needs for a bank (short duration deposits, commercial banks cost of funds and liquidity, retail bank cost of funds and liquidity)

short duration deposits, potential need for increased liquidity in adverse market conditions-->banks must maintain mandated liquidity coverage ratios (LCRs) and net stable funding ratios (NSFRs) commercial banks-->higher cost of funds, lower liquidity retail banks-->lower cost of funds, better liquidity

Inner Conflicts relating to LT and ST goals

short-term vs. long-term goals along with individual vs. social goals...reconciling may lead to behavior that is not perfectly rationale

Algo Trading

slice orders into smaller pieces and trade across venues and over time to reduce price impact of an orders 2) purposes: 1) execution: PM determins what to buy/sell 2) profit-seeking: algo determines what to buy/sell

SORs

small market orders with low market impact where the market can move quickly, and small limit orders with low info leakage, where there are multiple potential execution venues

Market Overviews: Exchange Traded Derivatives (large trades, non-urgent trades, DMA)

small, non-urgent trades are implemented using DMA electronic trading is common for exchange traded derivatives. algo trading is not as common as for equities and is used for more future than options

Tax considerations:

some assets are less tax efficient that others because of the character of their returns (interest, dividends, realized vs. unrealized cap gains)... pre-tax and after-tax risk and return characteristics of each asset class can be materially different: typically interest taxed the highest followed by dividends followed by capital gains... entities and accounts may also be subject to different tax rules... may provide opportunities for strategic asset location

Double taxation relief who have primary jurisdiction and who is expected to provide taxaation relief?

source countries ahve primary jurisdiction to tax income within its borders, residence conutry is typically expected to provide double taxation relief

Tehcnical Skills (what are the 6 technicals skills)

specialized knowledge and expertise necessary to provide investment advice some jurisdictions regulate minimum qualifications includes: capital market proficiency, portfolio construction, financial planning knowledge, quant skills, language flency, tech skills

When using factors as the unit of anlaysis (discuss asset classes in this context)

specify risk factors and desired exposure to each asset classes can be described by their sensitivities to each factor acknowledge that many highly correlated asset classes are better defined of the same higher level asset class

If having to compare 2 of the MVO graphs

state if the min and max variance portfolios are same. state if there is better diversificaiton (ie more asset classes in one over the other)

What are soverign wealth funds (definition)

state owned investment funds (invest in real or fin assets)

Emotional biases (Individual BFMI)::

stem from impulse or intuition reasoning influenced by feelings

Stock vs. Mutual companies

stock companies: profits accrue to shareholders mutual companies: profits accrue to policyholders (policy dividend)

Financial Capital (InvestmentAssets)

stocks, bonds publically traded marketable assets non-publically traded marketable assets: real estate, annuities, life insurance, vested employer pension, etc.

Satisficing

stop when they have arrived at a satisficatory decision...cost and time of optimal outcomes too high...complexity builds...

Tax Avoidance what is the definition

strategies that conform to both the spirit and the letter of tax codes

Global Market Value Weighted Portfolio:

sums all investable assets held by investors...reflects the balancing of supply and demand across world markets...baseline use min non-diversifiable risk and therefore makes the most efficient use of the risk budget...a reference point for a highly diversified portfolio (investor must provide justification for moving away from global market-cap weights), provides discipline in mitigating home country bias

LOcation of the gift tax liability do taxes on the gift increase/decrease if the donor pays some? what happens with cross border gifts wrt taxes?

tax liability of a gift may be with the donor or the recipient a cross border gift may result in both being taxes based on tax laws in each jurisdiction if donor pays taxes, the tax benefit of the lifetime gift vs. the bequest increases (tax paid decreases size of estate, and estate tax)

Life Insurance Types define temporary (or called term), permanent (within permanent there are whole life, universal, riders, accelerated death benefits, guaranteed insurability, waiver of premiums) within the above mentioned talk about cash value, premiums variability, impacts on investment selection,

temporary (or term): only for a specified period of time. cost is lower than permant life ins...no cash value...premiums remain fixed over the term of may increase as mortality risk increases permanent: provides lifetime coverage (as long as premium are paid over the entire period...premiums are usually fixed...usually some cash value within permanent there are the following types: Whole Life: Remains in force for insured'd entire life. requires ongoing fixed premiums. failure to meet payments can result in the lapse of the insurance policy. generally a cash value that may be accessed. non-cancelable (by the insurance company). may be participating (value may grow) 0r non-participating (fixed value). More restrictive in investment selection Universal life: more flexible. policy holder can pay higher or lower premium payments, more options for investing the cash value. insurance stays in force as long as premiums are paid or cash value can cover the policy expenses. Riders can be added to both types: adds some risk mitigation beyond the basic policy (i.e. accidental death and dismemberment). More examples of types of riders below: Accelerated Death Benefits: collect early if diagnosed as terminal guaranteed insurability: right to purchase more coverage at predefined intervals waiver of premium: if policyholder becomes disabled can also sell the policy to a 3rd party

Market impact and execution risk Temporary Market Impact Cost How to minimize info leakage Fast trading and execution risk Permanent component of price change associated with trading

temporary market impact cost: temporary, impact on security price from trading....usually price reversion after the order is complete permanent component of price change associated with trading is the market impact caused by the information content of the trade minimize info leakeage--> hide trades...execute over different venues using a mix of order types...use dark venues execution risk lower with faster trading tho trade too fast increased market impact

Liability relative (SAA):

tend to give fixed income a larger role than asset only for underfunded plans, equities would have a higher weighting risk factor approaches more relevant factors: interest rate sensitivity, inflation, credit risk

Benchmarking Commodity Investments

tend to use indexes based on performance of futures-based investments (considered investable) can vary greatyl in their composition and weighting actual funds use varying degrees of leverage (index typically delevered)

Technical Skills: Portfolio construction ability

that are appropiate for each client understanding of each asset class risks/returns, correlations, investment vehicles, managers, strategies, etc.

What decisions could the CIO and board endowment take to align the investment policy and the spendign policy?

the CIO and board could either change the investment policy by adopting an asset mix that has a more reasonable prob of acheviging a x% real rate of return. They could change the spending rate to more accurately reflect the expected real rate of retunr of the current investment policy

Tax Considerations (Public Traded Shares)

the form of a transaction may have differing tax treatments

Probate Definition talk about process length and cost how to avoid the probate process

the legal process to confirm the validity of the will so that executors, heirs, and other interest parties can rely on its authenticity the process can be lengthy and costly, delays the transfer of assets can be avoided (or its impact limited) by holding assets in other forms of ownership joint ownership with right of suvorvorship trusts insurance (eg. segregated funds)

Risk Budgeting (MVO):

the objective is to use risk efficiently in the pursuit of return. A risk budget specifies the total amount of risk and how much that risk should be budgeted for each allocation max return per unit of risk (ie desired risk or desired portfolio return vol = SD portfolio... 12 asset classes total MV... weights/asset class = asset class MV/total MV... asset class beta= sensitivity of asset class returns to portfolio (12 asset classes))... MCTR= marginal contributions to total risk (identifies the rate at which risk would change with a small change in the current weights)

Testator definition

the person who authorized the will and whose property is disposed of according to the will

Estate Planning definition

the process of preparing for the disposition of one's estate upon death and during one's lifetime

Investment Governance

the structure that is expected to ensure that assets are invested to achieve asset owner's investment ojective within risk tolerances and constraints (and in compliance with all applicable laws and regulations)

What are the adv of the three approaches for investors who are more interested in protecting the surplus than growing their assets? Assume that the investors has positive surplus

the three liab relative approaches are appropiate for conserative investors. All of the three approaches force investors to understand the nature of their laib. This type of info can help inform the decision making process

Expanded Implementation Shortfall

the time from receiving the order from the PM to actually placing the order...often resulting from time required to determine the trading strategy (broker or algo choice)

Principal trades

this is where dealers or market markers assume all or some of the risk relating to executing the order, which is priced into their spread. Quote driven, OTC or off-exchange markets are primarily principal trade markets. Principal trades also include request for quote markets where market makers do not provide continuous quotes but only do so on request

Agency Trades

this is where the broker finds the other side of the trade, and risk for order execution remains with the PM/trader

Returns Based Style Analysis (comparability, approach, data, objective check)

top-down approach... involves estimating the portfolio's sensitivies to security market indexes representing a range of distinct factors...not a precise too and not more accurate than holdings based analysis does not require a largel amount of difficult or hard to acquire data... comparable across managers and through time... provides an objective check not subject to window dressing... portfolio being analyzed may not reflect the current or future portfolio exposures... illiquid securities tend to have a stale prices (smoothed returns)

Max out of pocket expenses

total amount in a year a policy holder would pay after which the insurance company pays 100%

Execution algos

trade according to the rules specified by the manager to meet their objectives.

Net worth

traditional assets - traditional liability

Equity Monetization (Public Traded Shares)

transaction that allow the investor to recieve cash for their stock position rather than outright sale may bbe restricted from selling may not wish to cede control by selling may be subject to lockout, vesting, etc. Step 1: remove risk by hedging (requires care in structuring the hedge-complex tax regulations) Step 2: borrow against hedged position: typically a high LTV ratio can be achieved...reinvest in a diversifed portfolio... to do step 2 can: a) short sale against the box (short an equal/partial number of shares)....funds from short sale will earn rfr...position is now riskless, margin rules will allow investor to borrow with high LTV ratio, invested in a diversified portfolio....least expensive technique b) total return swaps: return on an index or at a fixed rate for the return on the position...should earn rfr (less dealer cut)...now borrow against the hedged position c) forward conversion with options: synthetic short position...should earn rfr...now borrow against the hedged position d) forward sale/single-stock futures contract: should generate rfr...now borrow against the hedged position Summary: riskless position is created....money market rate of return is generated...borrow with high LTV...rfr earned offsets return on loan (partially)...invest in diversified portfolio if tax authorities respect legal form over economic substance, equity monization should not trigger taxable event...other considerations 1) gain on the hedge (ST or LT gain) 2) loss on the hedge (ST or LT...currently deductible or does it modify the cost base of shares), 3) physical settlement: gain or LT, 4) interest expense on loan (deductible or does it modift the cost base of the shares), 5) does the hedge affect the taxation of dividends LOOK at hedging below for more detail 3) yield enhancement: covered calls (sets a liquidation value of the shares...keep all dividends and voting rights) 4) others: a) tax optimized equity strategy (index tracking strategy with active tax mgmt.; completeness fund) b) cross hedging, c) exchange funds

Outright sale (Public Traded Shares) talk implications (tax) for a sale and factors like vesting

triggers tax event maybe a restriction (vesting)

Hedging the value (Public Traded Shares)...what instruments do you use

typically derivatives

No downside fees and only participate in profits

typically most aggressive

Challenges to EMH

typically point out anomalies...1) fundamental (eg. Small cap and value companies...get better pricing model), 2) technical, 3) calendar

Wealth-based taxes (what is the formula)

typically property maybe on aggregate assets (including financial assets) above a certain maount formula: ((1+r)*(1-tax))^n

Style analysis (risk profile, style drift, comparisons to ojbective measures)

understand the manager's risk profile (risk exposures relative to the benchmark)... manager self-report risk exposures are compared to the results of a returns-based holding-based style analysis... should be consistent over time... deviations signal issues such as style drift... style analysis will be most useful with strategies that hold publically traded securities where pricing is frequent

Micro attribution

understanding the drivers of. manger's returns and whether those drivers are conssitent with the stated investment process

Unplanned goals

unforseen financial needs (more challenging to estimate amount and timing) ex. property repairs medical expenses other (funeral, elder care, etc.)

2) Factors determing the optimal order execution approach (trade governance)

urgency of order, rationale for a trade, characteristics of securities traded, characteristics of the execution venue used, investment strategy objectives

Holdings-based attribution

use actual holdings (beginning of period) all transactions are assumed to occur at end of day accuracy improves when data has shorter time intervals most appropiate for investment strategies with little turnover

Capitalized value

use or probability formula not AND

Arrival Price algos

used for relatively liquid securities when the order is not expected to have significant market impact. Arrival algos are also used when thePM and traders have higher levels of risk aversion and wish to trade more aggressively at an accelerated pace to reduce the execution risk associated with trading over a longer time horizon

Transactions based attribution

uses both the hodlings and the transactions during the evaluation period most accurate but most difficult and time consuming to implement choice of approach depends on the availability and quality of the underlying data

Returns based attribution

uses only total portfolio return most appropiate when underlying portfolio information is not available at the required frequency or detail easiest to implement...least accurate...vulnerable to data manipulation

Mostly cash allocation

usually for liquidity and stablity needs. Appropiate to meet ST lifestyle and education goals

Risk Aversion

utility function are concave and should show diminishing marginally utilitiy of wealth

Tax imlications for wealth managers

value created by using investment techniques that effectively manage tax liability (Tax alpha)

Income Yield Immediate Fixed Annuity what causes an income yield to be higher?

varies based on age and gender...the income yield is determined by estimating the average longevity of a given annuitant pool income yields will also vary based on the expected return the insurance company can earn on the premiums low bond yields +longer life spans = low income yields income yield is higher if longevity is shorter

Insurer Liquidit Needs (life and rates, P/C liquiity needs) Life--> P/C:

vary based on line of business Life-->disintermediation when rates rise, liquidity requirements rise P/C: ample liquidity due to uncertain value and timing of outflows...high proportions of cash and short term FI securities...marketable gov bonds of various maturities (laddered)

Foundations time horizon (limited life foundations)

very LT/perpetual, except for limited life foundations

Fully invested

violates mandate if they aren't...even if they go to cash

Broad market indexes

well recognized, easy to understand widely available not appropiate if manager stlye deviates considerable from the style refelected in the index

Sustinable spending rates

what %age of capital can be spent each year such that the prob of outliving assets is below some threshold level eg. prob of ruin <9% 4% of capital/yr = sustainable spending rate 500k spending needs core capital = 500k/.04=$12.5mn

Increasing the bands

when vol increases, when taxes increase, increasing transaction costs

Health Maintance Org (HMO) think office visists and cost

which allows ofice visits at no or v little cost to encourage individuals to seek help for small medical problems before they become serious

Profit seeking algos (who uses them, where are they employed, and what data is used)

who: electronic market makers, quants, high frequency traders used on electronic markets using real time data use real time market data to determine which securities to buy and sell, and are employed by electronic market makers, quant funds, and high frequency traders

lifetime gifts impacts to estate and inheritance taxes

will lower estate or inheritance taxes

Rationale ecomic man

will try to obtain the highest possible economic well being (utility) given: budget constraints, available information, will not consider the will-being of others...

Technical Skills: Financial planning knowledge

working knowledge of estate law, taxation, and insurance

Accrual Equivalent Tax Rate considerations

would increase if return has a larger component taxed at annual rates or fewer compnents with favorable rates, higher Taxes with smaller after tax accrual returns

Single asset conceptration (publically traded stock) give position contrentation amount explain strategy usually used

~25% position executive compensation over time scale of a business for stock LT buy and hold strategy

Improving execution Performance:

· Have a process in place that provides traders with broker performance metrics (reduce delay) · Determine proper order size for the market o Rather than tying up funds/time trying to fill a difficult trade, reduce the size and concurrently trade something else (reduce lost opportunity...typically the result of adverse price movement and or illiquidity)

Pooled or commingled vehicle:

· Money from multiple investor is held as a single portfolio and managed without potential customeization for any investor...

Market Overviews: Spot FX (what venue is it traded on and large/urgent trades)

· Primarily electronic trading · Large, urgent trades--> RFQ

Individual Seperately Managed Accounts (ownership, customization, tax, transparency, cost, tracking risk, investor behavior)

· ownership: investor owns the individual securities directly...liquidity events for other investors do not affect the account holder · Customerization: constraints/preferences can be handled · Tax efficiency: no capital gains taxes as a result of liquidity events in other accounts for other investors · Transparency: real-time, position level detail · Cost: SMAs do not scale well, higher transaction costs since trades cannot be aggregated · Traicking Risk: if SMA is customized performance will reflect investor constraints...makes attribution messy · Investor behavior: attempts to manage the account negatve the benefit of hiring a manager