Course Content
PORTFOLIO MANAGEMENT: AN OVERVIEW
This topic is covered in study session 18 of the material provided by the Institute. After reading this chapter, a student shall be able to: a. describe the portfolio approach to investing; b. describe the steps in the portfolio management process; c. describe types of investors and distinctive characteristics and needs of each; d. describe defined contribution and defined benefit pension plans; e. describe aspects of the asset management industry; f. describe mutual funds and compare them with other pooled investment products.
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Portfolio Approach to Investing
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Portfolio Management Process
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Types of Investors
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Pension Plans
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Aspects of Assets Management Industry
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Pooled Investments
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PORTFOLIO RISK AND RETURN: PART I
This topic is covered in study session 18 of the material provided by the institute. After reading this chapter, a student shall be able to: a. calculate and interpret major return measures and describe their appropriate uses; b. compare the money-weighted and time-weighted rates of return and evaluate the performance of portfolios based on these measures; c. describe characteristics of the major asset classes that investors consider in forming portfolios; d. calculate and interpret the mean, variance, and covariance (or correlation) of asset returns based on historical data; e. explain risk aversion and its implications for portfolio selection; f. calculate and interpret portfolio standard deviation; g. describe the effect on a portfolio’s risk of investing in assets that are less than perfectly correlated; h. describe and interpret the minimum-variance and efficient frontiers of risky assets and the global minimum-variance portfolio; i. explain the selection of an optimal portfolio, given an investor’s utility (or risk aversion) and the capital allocation line.
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Return Measures
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Money Weighted vs. Time Weighted Rate of Returns
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Risk Aversion
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Measures of Risk
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Portfolio Risk
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Minimum Variance Portfolio
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PORTFOLIO RISK AND RETURN: PART II
This topic is covered in study session 18 of the material provided by the institute. After reading this chapter, a student shall be able to: a. describe the implications of combining a risk-free asset with a portfolio of risky assets; b. explain the capital allocation line (CAL) and the capital market line (CML); c. explain systematic and nonsystematic risk, including why an investor should not expect to receive an additional return for bearing nonsystematic risk; d. explain return-generating models (including the market model) and their uses; e. calculate and interpret beta; f. explain the capital asset pricing model (CAPM), including its assumptions, and the security market line (SML); g. calculate and interpret the expected return of an asset using the CAPM; h. describe and demonstrate applications of the CAPM and the SML. i. calculate and interpret the Sharpe ratio, Treynor ratio, M2, and Jensen’s alpha.
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Risky and Risk-free Asset’s Portfolio
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Capital Allocation Line/ Capital Market Line
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Systematic and Non-Systematic Risk
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Return Generating Models
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Calculation and Interpretation of Beta
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CAPM and SML
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Application of CAPM
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BASICS OF PORTFOLIO PLANNING AND CONSTRUCTION
This topic is covered in study session 19 of the material provided by the institute. After reading this chapter, a student shall be able to: a. describe the reasons for a written investment policy statement (IPS); b. describe the major components of an IPS; c. describe risk and return objectives and how they may be developed for a client; d. distinguish between the willingness and the ability (capacity) to take risk in analyzing an investor’s financial risk tolerance; e. describe the investment constraints of liquidity, time horizon, tax concerns, legal and regulatory factors, and unique circumstances and their implications for the choice of portfolio assets; f. explain the specification of asset classes in relation to asset allocation; g. describe the principles of portfolio construction and the role of asset allocation in relation to the IPS. h. describe how environmental, social, and governance (ESG) considerations may be integrated into portfolio planning and construction.
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Investment Policy Statements
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Risk-Return Objectives
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Investment Constraints
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Asset Allocation
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ESG Considerations in Portfolio Management
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INTRODUCTION TO RISK MANAGEMENT
This topic is covered in study session 19 of the material provided by the institute. After reading this chapter, a student shall be able to: a. define risk management; b. describe features of a risk management framework; c. define risk governance and describe elements of effective risk governance; d. explain how risk tolerance affects risk management; e. describe risk budgeting and its role in risk governance; f. identify financial and non-financial sources of risk and describe how they may interact; g. describe methods for measuring and modifying risk exposures and factors to consider in choosing among the methods.
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Risk Management
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Risk Management Framework
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Risk Governance
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Risk Tolerance
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Risk Budgeting
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Sources of Risk
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Measuring & Modifying Risk Exposure
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TECHNICAL ANALYSIS
This topic is covered in study session 19 of the material provided by the institute. After reading this chapter, a student shall be able to: a. explain principles of technical analysis, its applications, and its underlying assumptions; b. describe the construction of different types of technical analysis charts and interpret them; c. explain uses of trend, support, resistance lines, and change in polarity; d. describe common chart patterns; e. describe common technical analysis indicators (price-based, momentum oscillators, sentiment, and flow of funds); f. explain how technical analysts use cycles; g. describe the key tenets of Elliott Wave Theory and the importance of Fibonacci numbers; h. describe intermarket analysis as it relates to technical analysis and asset allocation.
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Technical Analysis Explained
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Technical Analysis Charts
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Trend, Support, Resistance Lines, and Change in Polarity
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Common Chart Patterns
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Technical Indicators
00:00
Cycles
00:00
Inter-Market Analysis
00:00
Portfolio Management
About Lesson

LOS B requires us to:

compare the money-weighted and time-weighted rates of return and evaluate the performance of portfolios based on these measures

 

1.         Money-weighted Rate of Return

a.  The money-weighted rate of return (MWRR) is a measure of the performance of an investment in the portfolio.

b.  The MWRR is the internal rate of return of the portfolio i.e., it is the rate of discount at which the present value of all the cash outflows equals the present value of all the cash inflows.

PVOutflows = PVInflows

c.  While calculating the value of inflows, we consider the initial and final fund values and the intermediate cash inflows.

d.  The cash outflows include:

     i.  The beginning value or the purchase of an asset,

    ii.  Dividends and interests reinvested, and

   iii.  All the withdrawals made.

e.  The cash inflows include:

     i.  The final value of the fund or proceeds of investments sold,

    ii.  Dividends and interests received, and

   iii.  Contributions.

Example

If you invest in a mutual fund of $ 1,000 at the beginning of the year and sell the same at $ 1,100 at the end. There is also an annual dividend of $ 10.

So, the inflows = $ 1,000

And outflows = $ 1,100 + $ 10

We can calculate the MWRR by calculating the cash flow of this cash stream.

Or,

[(10) / (1 + r)] + [(1,100) / (1 + r)] = 1,000

If we calculate, the value of IRR is 11%.      

1.1.     Limitations of Using MWRR

a.  MWRR considers all cash flows during its calculations including the intermediate contributions and withdrawals. Thus, they give more weightage to the performance of the fund when it is at its largest.

b.  If the investor invests money just before the performance rise, there is a positive effect on the value. Whereas if the investor withdraws the money just before the performance surge, it has a negative impact on the performance of the fund manager.

2.         Time-Weighted Rate of Return

a.  The time-weighted rate of return (TWRR) is a measure of the compound rate of growth in a portfolio.

b.  This is considered a better measure of an investment manager’s performance because it does not consider the biased effect of inflows and outflows on the return, as in the case of MWRR.

2.1.     How to calculate Time-Weighted Rate of Return

a.  Divide the total holding period into sub-periods. This could be done based on a fixed interval (monthly, quarterly, annually, etc.) or on the basis of major inflows and outflows.

b.  Once the sub-periods have been assigned, calculate the holding period return (HPR) for each period.

c.  Add 1 to each HPR and multiply each (1 + H) term.

d.  Subtract 1 from the final product. The resulting value is compounded TWRR.

So, to sum up the formula for calculating TWRR is:

Compounded TWRR = [(1 + HPR1) × (1 + HPR2) × (1 + HPR3) × … … … (1 + HPRn)] – 1

 

e.  To annualize the above compounded TWRR, we add it with one and take its nth root and subtract one from the resulting figure. That is,

Annual TWRR = (1 + Compounded TWRR)1/n – 1

 

Example

Suppose we invest $ 1,000 in a unit stock ABC at the beginning of the year. The company pays a dividend of $10 per year at the end of the year. And at the end of the year, we again purchase an additional unit of the stock for $ 1,100. Suppose we sell both the units at the end of the second year at $ 1,200. What will be our TWRR?

Solution:

To do the same we first break the two-year period into two one-year periods.

Second, we calculate the holding period return of each periods, as follows

Particulars

Year 1

Year 2

Beginning Value

$ 1,000

$ 2,200
(2 shares × $ 1,100 each)

Dividends Received

$ 10

$ 20
(2 shares × $ 10 each)

Ending Value

$ 1,100

$ 2,400
(2 shares × $ 1,200 each)

HPR

11%
[i.e. (1,100 – 1,000 + 10) / 1,000 × 100]

10%
[i.e. (2,400 – 2,200 + 20) / 1,000 × 100]

1 + HPR

1.11

1.1

 

Lastly, we calculate the TWRR:

(1 + TWRR)2 = 1.11 × 1.10

TWRR = 0.1050 = 10.50 %

3.         MWRR vs TWRR

a.  Unlike MWRR, TWRR is not sensitive to the major outflows and inflows of funds, which is quite unfair in evaluating the fund manager’s performance. TWRR does not take into account the distorting effects of the major fund transfers.

b.  MWRR is only considered a better option if the fund manager has control over the flow and timing of the fund transfers.

 

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