> For the complete documentation index, see [llms.txt](https://shellder.gitbook.io/cfa/llms.txt). Markdown versions of documentation pages are available by appending `.md` to page URLs; this page is available as [Markdown](https://shellder.gitbook.io/cfa/level_3/institutional_investors_other_topics_in_portfolio_management_and_cases.md). # Institutional\_investors\_other\_topics\_in\_portfolio\_management\_and\_cases ## portfolio management for institutional investors ### institutional investors: common characteristics | | new | old | | - | -------------------------------- | --------------- | | S | stakeholders | | | L | liquidity needs | liquidity needs | | L | liquidity and investment horizon | time horizon | | E | external constraints | uniqueness | | R | risk | risk | | I | investment objectives | return | | A | asset allocation | | * scale * may impact investment capabilities, access to strategies, liquidity, trading costs * have a high minimum investment size * outsource 外部资源 * scale benefits * long-term investment horizon * pension funds, sovereign wealth funds, endowments, and foundations have long investment horizons and low liquidity needs. Low liquidity needs allow these institutions to invest in a broad range of alternative asset classes * banks and insurance companies tend to be much more asset/liability focused * regulatory frameworks * governance frameworks * board of directors and investment committee * board comprise company representative directors, employee representative directors, and independent directors * principal-agent issues ### overview of investment policy investment approaches: * Norway model: * sovereign wealth fund, 60%/40% equity/fixed-income, largely passive investments * pros: low cost, transparent, suitable for large scale, easy for board to understand * cons: limited value-added potential * endowment model * high alternative exposure, active management and outsourcing * pros: high value-added potential * cons: expensive and difficult to implement for most SWF because of large sizes; high costs * Canada model: pension plan * high alternative exposure, active management and internally managed assets * pros: high added value potential and development of internal capabilities * cons: potentially expensive and difficult to manage * Liability driven (banks and insurers) * focus on hedging liabilities and interest rate risk including via duration-matched, fixed-income exposure * pros: explicit recognition of liabilities as part of the investment process * cons: certain risks (e.g., longevity risk, inflation risk) may not change ### pension funds | characteristics | DB plan | DC plan | | -------------------------- | --------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------ | | benefit payments | defined by contract between employee and the pension plan | benefit are determined by the performance of investments selected by the participant | | contribution | the employer is the primary contribution | the employee is the primary contributor | | investment decision making | the pension fund determines how and what | the employee determines how and what | | investment risk | employer bears the risk | employee bears the risk | | mortality/ longevity risk | mortality risk is pooled. the individual does not bear any of the risk of outliving his/her retirement benefits | the employee bears the risk of not meeting his/ her objectives for this account. the employee bears longevity risk | #### stakeholders * DB plan: employer; plan beneficiaries (employees and retirees); the CIO and investment staff; the investment committee and/or board; and the government, unions, and shareholders in the case of corporate DB plans * DC plan: plan sponsor (employer), plan beneficiaries (e.g., the employee), the board, and the government. #### liabilities and investment horizon * DB plan `vesting`: a term indicating that employees only become eligible to receive a pension after meeting certain criteria, typically a minimum number of years of service. * some key elements common among DB plans in the calculation of expected cash flows: * service/ tenure * salary/ earnings * mortality/ longevity Funded ratio = fair value of plan assets / PV of DB obligations | factor | impact of increase in factor | | | ------------------------ | ---------------------------- | - | | service/ tenure | increase liability | | | salary | increase liability | | | longevity | increase liability | | | additional contributions | increase liability | | | employee turnover | lower liability | | | expected investment | lower liability | | | discount rate | lower liability | | * DC plan * `participant-switching life-cycle options`: **automatically** switch DC plan members into a more conservative asset mix as their age increases. There may be several automatic de-risking switches at different age targets. * `participant/cohort option`: pools the DC member with a cohort that has **similar target retirement date** #### liquidity needs * DB plan: liquidity needs are generally higher when: * proportion of retired lives in the plan is higher. Frozen plans will have higher liquidity needs since no addtional contribution. * workforce is older * if plan well funded, the plan sponsor may reduce contributions, generating a need to hold higher balances of liquid assets to pay benefits * the plan participants have the ability to switch or withdraw from the plan * DC plan: * age of the workforce and ability of participants to switch or withdraw from the plan #### risk considerations of DB | category | variable | explanation | | ---------------------------------------------- | ------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | | plan status | plan funded status (surplus or deficit) | higher pension surplus implies greater risk tolerance | | sponsor financial status and profitability | debt to total assets; current and expected profitability; size of plan compared to market capitalization of company | lower debt ratios and higher current and expected profitability imply greater risk tolerance; large company size relative to pension plan size implies greater risk tolerance | | sponsor and pension fund common risk exposures | correlation of sponsor operating results with pension asset returns | lower the correlation, greater the risk tolerance | | plan features | provision for early retirement; provision for lump-sum distributions | such options tend to reduce the duration of plan liabilities, implying lower risk tolerance | | workforce characteristics | age of workforce; active lives relative to retired lives | the younger the workforce and greater the proportion of active lives, the greater the duration of plan liabilities and the greater the risk tolerance | #### investment objectives * DB plan * the primary objective: to achieve a long-term target return over a specified investment horizon with an appropriate level of risk that allows the plan to meet its contractual liabilities. * the secondary objective could be to minimize the present value of expected cash contributions * if underfunded, additional contribution or make g\_A > g\_L * DC plan * primary objective: to prudently grow assets that will support spending needs in retirement * secondary objective: outperform the long-term policy benchmark #### external constraints * regulations * tax: favorable tax treatment * accounting rules #### asset allocation * equity decrease from 57% to 46% * alternative increased from 4% to 25% * home bias ### Sovereign wealth funds | type | objective | examples | | -------------------------- | ------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------- | | budget stabilization funds | set up to insulate the budget and economy from commodity price volatitily and external shocks | Russia's Oil Stabilization Fund | | development funds | established to allocate resources to priority socio-economic projects, usually infrastructure | Ireland Strategic Investment Fund | | Saving funds | Intended to share wealth across generations by transforming non-renewable assets into diversified financial assets | Russia's National Wealth Fund | | Reserve funds | Intended to reduce the negative carry costs of holding reserves or to earn higher return on ample reserves | China Investment Corporation | | Pension reserve funds | set up to meet identified future outlfows with respect to pension-related contingent type liabilities on governments' balance sheets | National Social Security Fund (China) | #### stakeholders * current and future citizens * investment offices * board * government #### liability and investment horizon * budget stabilization funds * uncertain liabilities, relatively **short** investment horizons * returns in excess of inflation with a low probability of a negative return in any year * development funds * liabilities **not clearly defined**, overall objective is to raise a country's economic **growth** or to **diversify** the economy * saving funds * liabilities are **long-term**. Some saving funds have a real return objective or an explicit spending policy * reserve funds * achieve a return higher than that on FX reserves * monetory stabilization bonds * investment horizons are **very long** * pension reserve funds * **long-term** investment horizons * accumulation phase / decumulation phase * meet future pension #### liquidity needs * budget stabilization funds * highest liquidity level * development funds * generally low liquidity needs * saving funds * lowest liquidity * reserve funds * liquidity needs are lower compared to stabilization funds but higher compared to saving funds * pension reserve funds * liquidity needs vary, being lower during the accumulation stage and higher during the decumulation stage saving funds < pension reserve funds on accumulation stage < development funds, reserve funds < pension reserve funds on decumulation stage < budget stabilization funds #### external constraints * legal regulatory * generally tax exempt #### investment objectives | SWF type | Investment objectives | | -------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | | budget stabilization funds | capital preservation; aims to earn returns above inflation with a low probability of losses; should avoid assets correlated with the source of government revenues | | development funds | support a nation's economic development and increase long-run economic growth; implicit objective is to earn a real rate of return greater than real domestic GDP growth or productivity growth | | saving funds | maintain purchasing power of the assets over time while making ongoing spending on government budgetary needs | | reserve funds | earn a rate of return in excess of the yield the government / central bank pays on bonds it has issued | | pension reserve funds | earn return to meet future unfunded pension and social care payments promised by the government | #### asset allocation * budget stabilization funds * the majority of fixed income and cash is due to the defensive nature of the fund * development funds * these are driven by the socioeconomic mission fo the fund (e.g., investment in local infrastructure projects) * saving funds * a long investment horizon means relatively high allocations toward equities and alternative investments such as private equity and real assets * reserve funds * allocation are similar to those of saving funds, but with lower allocation to alternatives due to the potentially higher liquidity needs * pension reserve funds * these have high allocations to equities and alternatives due to a long investment horizon and low liquidity needs in the accumulation phase ### university endowments #### stakeholders * current and future students, alumni and university employees * stakeholders often have representation on board or committee, such as alumni who may be investment professionals #### liability and investment horizon * a perpetual investment horizon * liabilities are future payouts promised to the university * should ensure smoothing payouts to insulate the university from market volatility * spending each year = weighted average of the previous year's spending and usually between 4% \~ 6% spending amount in year t+1 = w *\[spending amount in year t* (1 + inflation rate)] + (1 - w) *spending rate* average AUM #### liquidity needs * relatively low (compared to foundations) liquidity needs * high significant allocations to illiquid asset #### investment objectives * a total real rate of return of 5%, to be achieved over 3 to 5 years, with expected volatility of returns 10% to 15% * secondary investment objective: outperform the long-term policy benchmark * tertiary investment objective: outperform a set of pre-defined peers (average of the 20 largest university endowments) #### asset allocation rely heavily on alternative investments ### private foundations #### stakeholders * founding family, donors, grant recipients, and the broader community * board members for foundations are typically individuals involved with grant making and not necessarily investment professionals * mission-related investing: Aims to direct a significant portion of assets in excess of annual grants into projects promoting a foundation’s mission. * 较高成本完成特定任务 #### liability and investment horizon * perpetual investment horizons, although some foundations may have finite lives * legally required to pay out 5% of assets plus investment expenses * debt especially during periods of market stress * rely almmost exclusively on their investment portfolios to support operating budgets. More conservative, more liquid investment portfolios compared to endowments * a trend toward limited-life foundations as some founders seek to maintain control of spending while they are still alive #### liquidity needs * the liquidity needs is relatively low but still higher than those of university endowments | | US Foundation | US university endowment | | ------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------ | | purpose | grant-making for social, educational, and charitable purposes; principal preservation focus | general support of institution or restricted support; principal preservation focus | | stakeholders | founding family, donors, grant recipients, and braoder community that may benefit from foundation's activities | current/ future students, alumni, university faculty and administration, and the larger university community | | liabilities/ spending | legally mandated to spend 5% of assets + investment expenses + 100% of donations | flexible spending rules (headline spending rate with between 4% and 6% of assets) with smoothing | | other liability considerations | future gifts and donations, or just one-time gift? | gifts and donations, percentage of operating budget supported by endowment, and ability to issue debt. | | very long-term/ perpetual (except limited-life foundations) | perpetual | | | risk high risk tolerance with some short-term liquidity needs | high risk tolerance with low liqudity needs | | | liquidity needs | annual net spending is at least 5% of assets | annual net spending is typically 2% to 4% of assets, after alumni gifts and donations | #### external constraints affecting investment * legal and regulatory constraints * tax and accounting constraints #### investment objectives * primary investment objective: to generate a total real return over consumer price inflation of 5%, plus investment expenses, with a reasonable expected volatility (10% - 15% std) over a 3 - 5 year period * secondary investment objective: outperform the policy benchmark with a specified tracking error budget #### asset allocation Foundations tend to follow a similar investment approach compared to endowments. Two of the most notable differences between foundations and endowments: 1. foundations support the entire budget of their organization, while universities have significant other sources of financing available besides the endowment 2. foundations are mandated to pay out at least 5% of their assets to maintain tax-exempt status and typically receive no additional inflows in the form of gifts and donations, whereas university endowments typically have a net payout of less than 5% 3. larger foundations have higher percentage of alternatives investment and lower portion of bonds ### banks and insurers * bank * insurer * life insurers * property and casualty (P\&C) insurers ### banks #### stakeholders * external parties: shareholders, creditors, customers, credit rating agencies, regulators, and the communities where they operate * internal parties: employees, management, and boards of directors * on the liability side, bank customers are comprised of a variety of depositors: financing, safekeeping, transaction, fixed-income issuers * on the asset side, mortgages, commercial real estate loans and commercial and industrial loans #### liabilities and investment horizon bank assets = loans + debt securities + currency + deposits with central banks, receivables and bullion bank liabilities = deposits + short-term funding + longer term debt Bank deposits include the following: * time deposits or term deposits: interest-bearing accounts that have a specified maturity date. This category includes savings accounts and certificates of deposit. * demand deposits: accounts that can be drawn upon regularly and without notice. This category includes checking accounts and certain savings accounts that are often accessible through online banks or automated teller machines. The difference between the long time horizon of the institution and much shorter maturity of most of its assets and liability may ssem counterintuittive. The long-term horizon of the bank is evidenced by: 1) cutting back new lending, 2) selling part of its existing loan porfolio, 3) increasing allocations to short-maturity, liquid securities, and 4) decreasing leverage through fewer large wholesale time deposits #### liquidity needs In general, contrasting commercial banks and retail-oriented banks, commercial banks have a higher cost of funds and lower liquidity because of wholesale funding of loan commitments and other contingent commitments. Conversely, retail banks have a lower cost of funds and better liquidity because their retail deposits are relatively low cost and tend to be more stable. ### insurers #### stakeholders * external parties: shareholders, derivatives counterparties, policyholders, creditors, regulators and rating agencies * internal parties: employees, management, and boards of directors. * general account: account holding assets to fund future liabilities from traditional life insurance and fixed annuities, the products in which the insurer bears all the risks particularly mortality risk and longevity risk. * separate accounts: accounts holding assets to fund future liabilities from variable life insurance and variable annuities, the products in which customers make investment decisions from a menu of options and themselves bear investment risk #### liabilities and investment horizon * life insurers: face a liability stream and timme horzion with a long duration, 20 to 40 years * property & casualty insurers: face a shorter duration liability stream and investment horizon than life insurers with lower probability of occurrence and potentially higher cost, i.e., short durationo and high uncertainty ### liquidity needs liquidity needs can vary greatly based on the business line * internal liquidity: cash and cash equivalents * external liquidity: issue bonds and access credit lines * manage short-term liquidity by actively buying and selling repurchase agreements ### external constrints affecting investment * legal and regulatory constraints * clearly and contractually defined * the need to regulate banks and insurance companies at high levels, rather than local * accounting and tax considerations * standard financial accounting * statutory accounting: usually results in lower earnings and lower common equity capital * true economic accounting: provide best picture of an entity's assets, liabilities and changes in economic well-being ### invesment objectives * banks: manage the bank's liquidity and risk position relative to its non-securities assets, derivatives positions, liabilities, and shareholders' capilitalization * insurers: manage the investment porfolios with a focus on liquidity as well as interest rate, foreign exchange, credit and other risk factor ### banks and insurers - balance sheet management and investment considerations In the case of banks and insurance companies, the need is to fund deposits, policy claims, derivatives payoffs, and debtholders. The underlying investment strategy is mainly liability driven investing (LDI as earlier defined) $$A = L + E$$ $$\Delta A = \Delta L + \Delta E$$ so we have $$\frac{\Delta E}{E} = \frac{\Delta A}{A}(\frac{A}{E}) - \frac{\Delta L}{L}(\frac{A}{E} - 1)$$ Small losses in the market value of assets can have a pronounced negative effect on the institution's equity account because of the leverage factor Financial institutions face the possibility of loss from adverse changes in the market value of liabilities. * insurers company: unexpectedly high policy loss claim * banks: make a forward-funding commitment, the exercise of a guarantee, or a loss on forward currency purchase contracts. $$D\_E^\* = (\frac{A}{E}) D\_A^\* - (\frac{A}{E} - 1) D\_L^\* (\frac{\Delta i}{\Delta y})$$ $$\sigma^2\_{\frac{\Delta E}{E}} = (\frac{A}{E})^2 \sigma^2\_{\frac{\Delta A}{A}} + (\frac{A}{E} - 1)^2 \sigma^2\_{\frac{\Delta L}{L}} - 2 (\frac{A}{E}) (\frac{A}{E} - 1) \rho \sigma\_{\frac{\Delta A}{A}} \sigma\_{\frac{\Delta L}{L}}$$ | portfolio strategy considerations | main factors affected | explanation/ tationale | additional regulatory concerns | | ----------------------------------------------------------------- | ----------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------ | | diversified fixed-income investments | decreases sigma\_A | | | | high-quality bond/ debt investment | decreases sigma\_A | | | | maintain reasonable balance between asset and liability durations | increase rho | | | | common stock investments | increase sigma\_A typically decreases rho | | | | derivatives transparency, collateralization | decreases both sigma\_A and sigma\_L and increase rho | | | | liquidity of porfolio investments | decreases sigma\_A | | | | surrender penalties | decrease sigma\_L | such penalties cushion losses to financail institutions for having to pay back liabilities at par when rising interest rates would otherwise have reduced the discounted present value of the obligations | | | prepaymant penalties on debt investments | increase rho | When interest rates are declining, borrowers must incur a penalty to repay loans at par to refinance. | | Also, prepayment penalties help institutions offset rising values of their fixed-rate liabilities in falling rate environments. | | | catastrophic insurance risks | increases sigma\_L | | | | predicatability of underwriting losses | decreases sigma\_L | High frequency, low cost loss events caused by law of large numbers make total insurance liabilities less uncertain. | | | diversifying insurance business | decreases sigma\_L | | | | variable annuities | increases rho, and sigma\_A & sigma\_L diminish in relevance | | | ## Trade strategy and execution ### Motivations to trade * profit seeking * short-term profit motivated trading * long-term profit motivated trading * risk management/ hedging needs * cash flow needs * corporate actions/ index reconstitutions/ margin calls ### Trading strategies and strategy selection * trade strategy inputs * order characteristics * side: buy, sell, cover, or short * size * relative size (% of ADV) * security characteristics * security type * short-term alpha * price volatility * security liquidity * market conditions: liquidity crises * user-based considerations: trading cost risk aversion * market impact and execution risk: * Trader's dilemma: Trading too fast results in too much market impact, but trading too slow results in too much market risk ### Reference prices * pre-trade benchmark * decision price * previous close * opening price * arrival price * intraday benchmark * VMAP(volume weighted average price) * TWAP * post-trade benchmark * closing price * price target benchmark ### Trade strategies * short-term alpha: short-term alpha-driven equity trade * long-term alpha: long-term alpha-driven fixed-income trade * risk rebalance: buy/sell basket trade to rebalance a fund's risk exposures * cash flow driven: client redemption trade to raise proceeds * cash flow driven: cash equitization trade to invest a new client mandate ## Trade execution ### Trade implementation choices * principal trades/ broker risk trades, market makers and dealers become a disclosed counterparty to their clients' orders and buy securities into or sell securities from their own inventory or book. * quote-driven, over-the-counter, or off-exchange markets: in such bilateral dealer markets, customers trade at prices quoted by dealers. * request for quote (RFQ): A non-binding quote provided by a market maker or dealer to a potential buyer or seller upon request. Commonly used in fixed income markets these quotes are only valid at the time they are provided. * Direct market access (DMA): Access in which market participants can transact orders directly with the order book of an exchange using a broker's exchange connectivity. ### Algorithmic trading * execution algorithms * scheduled: POV(percentage of volume), VWAP, TWAP * liquidity seeking: opportunistic algorithms * arrival price: Arrival price algorithms seek to trade close to current market prices at the time the order is received for execution * Dark strategies/liquidity aggregators: execute shares away from “lit” markets * smart order routers: choose best order and venue * profit-seeking algorithms ### comparison of markets * equities * alternative trading systems * multilateral trading facilities * fixed incomme * exchange-traded derivatives * off-excahnge (OTC) derivatives * spot currencies ## Trade evaluation ### trade cost measurement * implementation shortfall: difference between the return for a notional or paper portfolio $$IS = paper\ return - actual\ return$$ $$paper\ return = (P\_n - P\_d)S = S P\_n - S P\_d$$ where, S = total order shares, S > 0 for buy, S < 0 for sell, Pd = price at the time of the investment decision, and Pn = the current price $$Actual = (\sum s\_j) P\_n - \sum s\_j p\_j - Fees$$ $$IS = execution\ cost + opportunity\ cost + Fees = \sum s\_j p\_j - \sum s\_j p\_d + (S - \sum s\_j)(P\_n - P\_d) + Fees$$ * expanded implementaiton shortfall $$Expanded\ IS = delay\ cost + trading\ cost + opportunity\ cost + Fees = \sum s\_j p\_0 - \sum s\_j p\_d + \sum s\_j p\_j - \sum s\_j p\_0 + (S - \sum s\_j)(P\_n - P\_d) + Fees$$ Delay cost: The (trading related) cost associated with not submitting the order to the market in a timely manner ### trade governance * meaning of best execution * executing price * trading costs * speed of execution * likelihood of execution and settlement * order size * nature of the trade * factors determining the optimal order execution approach * urgency of an order * charactreristics of the securities traded * characteristics of the execution venues used * investment strategy objectives * rationale for a trade * listing of eligible brokers and execution venues * quality of service * financial stability * reputation * settlement capabilities * speed of execution * cost competitiveness * willingness to commit capital * process to momitor execution arrangements * trade submission: has the trading/ execution strategy been implemented consistent with the investment process, and is it optimal for the asset type traded? * what was the execution quality of a trade relative to its benchmark * is there an appropriate balance between trading costs and opportunity costs * could better execution have been achieved using a differenct trading strategy, different intermeidaries, or different trading venues trading records may be used to do the following: * address client concerns * address regulator concerns * assist in improving execution quality * monitor the parties involved in trading/ order execution ## Portfolio performance evaluation ### the components of performance evaluation * performance measurement - what was the portfolio's performance * performance attribution - how was the performance achieved * performance appraisal - was the performance achieved through manager skill or luck? excess return: 1) the difference between the portfolio return and the benchmark return; 2) the return in excess of the risk-free rate ### performance attribution an effective perfromance attribution process must * account for *all* of the portfolio's return or risk exposure, * reflect the investment decision-making process, * quantify the active decisions of the portfolio manager, and * provide a complete understanding of the excess return/ risk of the portfolio performance attribution includes: return attribution and risk attribution * micro attribution: attribution at the portfolio manager level * macro attribution: attribution at the sponsor level performance attribution may be either returns based, holdings based, or transactions based. * returns-based attribution: uses only the total portfolio returns over a period to identify the components of the investment process that have generated the returns * holdings-based attribution: a "buy and hold" attribution approach which calculates the return of portfolio and benchmark components based upon the price and foreign exchange rate changes applied to daily snapshots of portfolio holdings * transactions-based attribution: an attribution approach that captures the impact of intra-day trades and exogenous events such as a significant class action settlement ### approaches to return attribution arithmetic attribution ($R - B$) / geometric attribution ($\frac{1 + R}{1 - B} - 1$) #### equity return attribution - the Brinson Model $$Excess\ return = R - B = \sum{w\_i R\_i} - \sum{W\_i B\_i} = \sum{A\_i} + \sum{S\_i} + \sum{I\_i}$$ where $A\_i$ is allocation attribution, $A\_i= (w\_i - W\_i) B\_i$, $S\_i$ is selection attribution, $S\_i = W\_i(R\_i - B\_i)$, $I\_i$ is interaction attribution, $I\_i = (w\_i - W\_i)(R\_i - B\_i)$ #### equity return attribution - Factor-Based Return Attribution Carhart model: $$R\_p - R\_f = a\_p + b\_{p1} RMRF + b\_{p2} SMB + b\_{p3} HML + b\_{p4} WML + E\_p$$ where $R\_p$ and $R\_f$ = the return on the portfolio and the risk-free rate of return, respectively $a\_p$ = "alpha" or return in excess of that expected given the portfolio's level of systematic risk $b\_p$ = the sensitivity of the portfolio to the given factor $RMRF$ = the return on a value-weighted equity index in excess of the one-month T-bill rate $SMB$ = small minus big, a size factor, < 0 means large-cap oriented $HML$ = high minus low, a value factor, high book-to-price - low book-to-price, > 0 means value-oriented $WML$ = winner minus losers, a momentum factor, past year's winners - past year's losers $E\_p$ = an error term that represents the portion of the return to the portfolio, p, not explained by the model #### fixed-income return attribution * exposure decomposition - duration based * yield curve decomposition - duration based * yield curve decomposition - full repricing based we can infer the following about the portfolio investment process over this period: * yield * roll * shift * slope * curvature * spread * specific spread * residual ### risk attribution | investment decision-making process | relative(vs. benchmark) | absolute | | ---------------------------------- | ------------------------------------------------------------------------ | -------------------------------------------------------------- | | bottom up | position's marginal contribution to tracking risk | position's marginal contribution to to total risk | | top down | attribute tracking risk to relative allocation and selection decisions | factor's marginal contribution to total risk and specific risk | | factor based | factor's marginal contribution to tracking risk and active specific risk | factor's marginal contribution to total risk and specific risk | for relative, a common measure of risk is tracking risk; for absolute mandates, the risk of portfolio is explained by exposures to the market, size and style factors, and the specific risk due to stock selections. * marginal contribution to total risk: bottom-up with an absolute return target * marginal contribution to tracking risk: bottom-up with a relative return target * factor's marginal contributions to total risk and specific risk: top-down with an absolute return target ### return attribution analysis at multiple levels * macro attribution * micro attribution ## benchmarking investments and managers in investment practice, we use benchmarks as ### asset-based benchmarks * asset-based benchmarks * absolute return benchmark * broad market indexes * style indexes * factor-model-based benchmarks: $R\_p = a\_p + b\_1 F\_1 + b\_2 F\_2 ... b\_k F\_k + \epsilon\_p$ * returns-based benchmark * manager universes * custom security-based benchmarks ### properties of a valid benchmark * unambiguous * investable * measurable * appropriate * reflective of current investment opinions: * specified in advance: the benchmark must be constructed prior to evaluation period so that the manager is not judged against benchmarks created after the fact. * accountable: the manager should be able to demonstrate the validity of his or her benchmark ### evaluating benchmark quality $$P = M + S + A$$ where M = market index return, S = manager's style return, A = active management decision ### benchmarking alternative investments * hedge fund investments * real estate investments * private equity * commodity investments * managed derivatives * distressed securities ## Performance appraisal * distinguish investment skill from luck * appraisal measures * Sharpe ratio * Treynor ratio * Information ratio * Appraisal ratio * Sortino ratio * Capture ratios ## Case study in portfolio management: institutional tools at insitutional investors disposal to manage a portfolio's liquidity risk, including: * liquidity profiling and time-to-cash tables * time-to-cash table and liquidity budget | time to cash | liquidity classification | liquidity budget (% of portfolio) | | ------------ | ------------------------ | --------------------------------- | | < 1 week | highly liquid | at least 10% | | < 1 quater | liquid | at least 35% | | < 1 year | semi-liquid | at least 50% | | > 1 year | illiquid | up to 50% | * rebalancing and commitment strategies * systematic rebalancing policies: such as calendar rebalancing and percent-range rebalancing * automatic adjustment mechanisms * strees testing analysis * derivatives * earning an illiquidity premium