IEF 213 - Portfolio Management

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IEF 213 - Portfolio Management

    GSIEF 213B International Portfolio Management Ron D’Vari, Ph.D., CFA Managing Director, Director of Fixed Income Research

    State Street Research and Management (MetLife Asset Management Subsidiary)


Portfolio management is both an art and a science. It is a dynamic decision making process, one that is

    continuous and systematic but also requires a great deal of judgment. The objective of this class is to blend

    theory and practice to achieve a consistent portfolio management process. This dynamic process is

    designed to be applied in a comprehensive and logical fashion to variety of objectives and constraints in an

    increasingly more volatile and global capital markets.

This class will discuss various theories and widely used techniques for combining different investments to

    create portfolios meeting specific goals and objectives within given risk parameters. This class will include

    in-depth exploration of many of the concepts introduced in CSS-318 (Investments: Theory and

    Application). These include selecting suitable investment policies and strategies, balancing asset classes,

    integrated risk management, efficient diversification, market efficiency, measuring and attributing

    performance for an investment portfolio. Some considerations are given to analyzing international assets

    and techniques of using them both opportunistically (tactically) and strategically. Specific risks of global

    investing such as country, political, currency, convertibility, liquidity and settlement are treated. Key

    issues in managing emerging market portfolios are analyzed.

This course is modeled after portfolio management curriculum for CFA levels I through III.

Key Features

    ? Portfolio management within the context of the overall plan asset allocation

    ? Drivers of asset allocation decision

    ? Matching a client's risk preferences and return goals with different investment options

    ? Style consistency within the context of policy absolute and relative risk

    ? Risk/return tradeoffs as an integral theme throughout portfolio management

    ? Performance attribution as key to portfolio management success

    ? Common investment management styles in stocks, bonds, real estate, and commodities

    ? Key differences between fixed income and equity portfolio management

    ? Portfolio management applications using derivatives

    ? Global perspective through complete integration of international investment markets and topics

    ? Basics of industry analysis, security analysis, and portfolio construction

Text Books

1) Investment Analysis and Portfolio Management, Frank K. Reilly & Keith C. Brown, Sixth Edition,

    2000, The Dryden Press (ISBN: 0-03-025809-X)

Class Grading:

    ? Team project including final presentation 25%

    ? Mid term project report and presentation 15% ? Take Home Final Examination 30%

    ? Assigned Homework 20%

    ? Added-value participation in class discussions 10%

Office Hours: After each class.


Sessions 1-3: The Investment Background

    Sessions 4-5: Introduction to Portfolio Management and Asset Pricing Models

    Sessions 6-7: An Introduction to Basic Principles of Financial Asset Management

    Sessions 8: Determination of Investment Objectives, Constraints, and Portfolio Policies

    Sessions 9-10: Valuation Principles, Practices and Expectations for Capital Markets

    Sessions 11-12: Integrating Expectational Factors and Portfolio Policies and Constructing Portfolios

     Portfolio Management of Fixed-income and Equity Portfolios

    Sessions 13-14: Portfolio Management Applications Using Derivatives

    Session 15: Emerging Markets

    Session 16: Final Project Presentations


    Sessions 1-3: The Investment Background

    The Investment Setting

    - Measures of return and risk

    - Determinants of required rates of return

    - Relations between risk and return

    - Appendix: Basic Quantitative Skills: Calculation of historical returns, Mean, Variance, and

    Standard Deviation, Portfolio Return Calculation,

    The Asset Allocation Decision

    - Investor types - individual and institutional

    - The Portfolio Management Process

    - The importance of asset allocation

    Investments In a Global Market

    - The case for global market

    - Alternative security choices in a global market

    - Historical risk/return characteristics of different asset classes Organization of Different Securities Markets

    Security Market Indicators

    Sources of Information on Global Investments

    Readings: Reilly/Brown, Chapters 1-6.

    Group Assignments:

    1. Form a Project Team, Initiate Setting Portfolio Objectives

    2. For the following asset classes (Stocks , Bonds, Commodities, Real Estate) identify the

    following (due by week 3):

    - Major markets indices

    - Risk/return characteristics

    - Liquidity and market transparency

    - Propose ways to invest and actively outperform major market indices

    Sessions 4-5: Introduction to Portfolio Management and Asset Pricing Models

    Review of Basic Portfolio Analytics

    - Performance measurements and attribution basics

    - Evaluation of portfolio performance

    - Peer group

    - Sharpe, Treynor, Jenson, and Information Ratio performance measures

    - Expected return and standard deviation of individual assets and portfolios

    - Efficient Frontier

    - The efficient frontier and investor utility function

    - Standardized measure of systematic risk beta

    - Identifying undervalued and overvalued assets based on CAPM

Capital Asset Pricing Models (CAPM)

    Systematic and Unsystematic Risks in Individual Securities

    Capital Market Line (CML) and Security Market Line (SML)

    Readings: Reilly/Brown, Chapters 7-9, and 26-27

    Group Assignments:

    1. Formulate Portfolio Objectives and Investment Policies for a Typical Institutional Investor of

    Your Choice, e.g. an employee benefit fund (Due by 4)

    2. Write a brief report on how you would calculate/measure the following measures for a

    portfolio (due by week 5)

    - Absolute and relative return

    - Absolute and relative risk (historical and prospective)

    - Benchmark comparison (systematic, sector, and security)


    Include an example with at least three securities and four periods of returns. Due week four.

    Sessions 6-7: An Introduction to Basic Principles of Financial Asset Management

    Portfolio Management as a Dynamic Process

    - Objectives, Preferences, Constraints Including Time Horizon, Liquidity, and Applicable Laws

    - Investment Guidelines

    - Asset Mix Policy Decisions

    - Benchmark(s) Selection

    - Dynamic Market Monitoring, Portfolio Construction and Revision

    - Performance Measurement and Attribution

    Portfolio Management Basics

    - Asset Markets and Their Efficiency

    - Return Measurement

    - Return Expectations and Scenario Analysis

    - Risk Analysis Definitions and Measurements

    - Modern Portfolio Theory

    - Asset Pricing Theories

    - CAPM, APT, International Asset Pricing

    - Investor Risk Aversion and Utility Functions

    - Portfolio Management Concepts

    - Passive

    - Enhanced Passive

    - Active

    - Manage relative risk/return - Benchmark focused

    - Manage absolute risk/return Absolute return focused

    - Top-down

    - Bottom-up

    - Top-down/Bottom-up

Extensions and Testing of Asset Pricing Theories (APT)

Derivative Markets and Securities

    Readings: Reilly/Brown, Chapters 10-11.

    Group Assignments: 1) Forecast long term and short term macro economic environment and its impact on various asset

    classes’ risks and returns. Include expected nominal and real growth, inflation, and currencies for

    all countries your team intends to invest in.

    2) Formulate a tactical asset allocation strategy for the portfolio you intend to manage

    - Highlight key characteristics of your approach (top-down, bottom-up, quantitative,

    fundamental, etc.)

    3) Set up a consistent framework to measure your portfolio

    - Absolute and relative performance

    - Absolute and relative risks measures to be managed and monitored

    - Approach to attribution (Market allocation, sector allocation, security selection) 4) Identify a source of pricing for your portfolio and indices you intend to use

    Session 8: Determination of Investment Objectives, Constraints, and Portfolio Policies

    Individual Investors

    - Demographic of Individual Investors

    - Rational Goal Settings for Individual Investors

    - Investment Constraints for Individuals

    - Determination of Portfolio Policies

    - Risk Control Issues


Institutional Investors

    - Employee Benefit Funds (Defined Benefit, Defined Contribution, Health Care Benefits, Others)

    Pension Plan Investment Policy and Investment Mandates

    Liquidity Requirements

    Regulatory and Legal Considerations

    Decisions on Changes in Asset Allocation

    Unique Needs and Circumstances - Endowment Funds

    Return Requirements and Objectives and Their Relationship to Spending Rate and Inflation

    Regulatory and Legal Considerations

    Unique Needs and Circumstances - Insurance Companies

    Life Insurance

    Non-life Insurance Companies - Commercial Banks

    - Investment Companies (Open- and Closed-end Mutual Funds)

    Readings: TBD


    1) Establish initial asset/sector allocation and start to trade your portfolios. 2) Construct a trial portfolio based on your team investment guidelines and strategies and rebalance it


    3) Identify absolute risk and relative risk of your portfolio vs. benchmark 4) Measure return of your portfolio and its benchmark weekly

    5) Devise a performance attribution methodology for your portfolio and benchmark and apply it on

    weekly basis.

    6) Prepare weekly summary report including: a) market outlook updates, b) portfolio actions, c)

    portfolio absolute and relative risks to its benchmark, d) weekly and cumulative performance of

    portfolio and benchmark and their attribution.

    Weekly reports are to be turned in with the final project report.

    Sessions 9-10: Valuation Principles, Practices and Expectations for Capital Markets

    Security Valuation

    - Review of Financial Statement Analysis

    - Security Valuation Models

    Macro Factors

    - Forecasting Inputs for Security Analysis and Portfolio Management

    - Framing the Forecast By Asset Class

    - Key Macro Variables That Drive Security Pricing and Returns

    - Macro Valuation Models - Macro Economic Variables

    - Long Term Expectations and Real Growth

    - Short Term Expectations - Inflation/Deflation And Its Impacts on Returns of Various Asset Classes - International Economics and Security Returns

    Individual Asset Classes

    - Significance of Asset’s Systematic and Unsystematic Risks

    - Importance of Pervasive Factors on Formation of Return Expectations - Three Main Asset Classes - Stocks, Bonds, Real Estate

    - Factors Influencing Expected Returns

    - Equity

    - Fixed Income

    - Real Estate

    - Modifying Expectations With Futures and Options

    - Integrating Assets Into A portfolio

    - Within an Asset Class


    - Across Asset Classes

    Readings: Reilly/Brown, Chapters 12-14.

    Assignments: th1. Mid-term class presentation on your project in week 9

    - 15 Minutes per team

    - Overview of objectives, investment style, and preliminary results

    2. Continue weekly team portfolio management project

    Sessions 11-12: Integrating Expectational Factors and Portfolio Policies and Constructing Portfolios

    Overview of Asset Allocation

    - Investment as a multiple stage process and importance of asset allocation - Major Steps in Asset Allocation

    - Various Asset Allocation Approaches

    - Integrated and Dynamic

    - Strategic Asset Allocation

    - Tactical Asset Allocation

    - Insured Asset Allocation - Investors Objectives and Constraints

    - Capital Market Forecasts

    - Extrapolation of Historical Data

    - Scenario Approaches

    - Risk and Correlation Models

    - Equilibrium Models - Asset Allocation Solution Techniques

    - Linear Programming

    - Quadratic Programming

    - Monte Carlo Approach

    - Utility-Function Approach to Asset Mix Selection - Dynamic Strategies

    Overview of Equity Portfolio Management

    - Role of The Equity Portfolio

    - International Equities

    - Passive Strategies

    - Domestic and Global Indices

    - Construction Techniques

    - Factor/Style Funds

    - Index Arbitrage - Active Strategies

    - Styles

    - Role of Style Benchmarks

    - Impact of Pear-group Performance Comparison

    - Structuring of Active Portfolios

    - Strategies: Top-down, Bottom-up, Core, Specialized, and Quantitative

    - Hybrid Products

    - Combination of Active and Passive

    - Equity Style Investing

Overview of Fixed-Income Portfolio Management

    - Risk/Return Characteristics of Fixed-Income Portfolios Including Time Horizon - Interest Rate and Curve Risks - Spread Risk

    - Uncertain Cash Flow Risk

    - Passive Buy-And-Hold Strategy

    - Quasi-Passive Indexation Strategies

    - Sampling

    - Stratified


    - Structured Portfolio Strategies

    - Immunization

    - Dedication

    - Cash Flow Matching

    - Optimization

    - Active Strategies or Total Return Approach

    - Interest Rate Anticipation

    - Curve Positioning

    - Sector Rotation

    - Security Selection

    - Yield Enhancement

    - Opportunistic Investments in International, High Yield, or Emerging Market Fixed-income


    - Optimization

    - Derivatives Overlay

Readings: Reilly/Brown, Chapters 15-22.


    1) Continue weekly team portfolio management project

    2) For the following asset classes (Stocks , Bonds, Commodities, Real Estate) identify the following

    (due by week 12):

    - Major investment styles and products

    - Core competencies required to manage each style

Sessions 13-14: Portfolio Management Applications Using Derivatives

    - Futures, Options & Swaps

    - Interest Rate Futures: Refinements

    - Stock Index Futures: Refinements

    - Option Payoffs and Option Strategies

    - Option Sensitivities and Option Hedging

    - The Swaps Market: Refinements

    - Minimizing Cash Drag with S&P 500 Index Tools

    - Using Interest Rate Futures in Portfolio Management

Readings: Reilly/Brown, Chapters 23-25 and Instructors Notes.


    1) Continue weekly team portfolio management project.

    2) Close out your portfolios by the end of Week 14

Session 15: Emerging Markets

- Case for emerging market investing

    - Defining emerging markets

    - Emerging markets current and long-run expected conditions

    - Key issues in managing emerging market portfolios

    - Top-down investing in emerging markets

    - Bottom-up investing in emerging markets

    - Valuation techniques for emerging market securities

    - Style investing implications for the global emerging markets

    - Current topics

    - Wrap-up

    Take-home final to be passed out to the class on the last class (session before final’s week)


    Readings: Selected readings to be assigned. Assignments:

    1) Final project report due.

Session 16: Final Project Presentations

    - Project presentations

    - Take-home finals and project write-ups to be collected


    1) Take-home finals to be turned in.


Optional Readings

1. Singer, B.D., Terhaar, K., “Economic Foundations of Capital Market Returns”, The Research

    Foundation of Institute of Chartered Finanacial Analysis, September 1997.

    2. Blingsley, R.S., “Equity Securities Analysis Case Study: Merck & Company”, AIMR, 1993

    3. Cohen, M.I., Oakley, K.,“RJR Nabisco – Addition by Subtraction”, U.S. Research, Goldman, Sachs

    and Co., May 25, 1994.

    4. Gorman, S.A., “The International Equity Commitment,” The Research Foundation of Institute of

    Chartered Finanacial Analysis, August 1998.

    5. Erb, C.B., Harvey, C.R., Viskanta, T.E.., “Country Risk in Global Financial Management,” The

    Research Foundation of Institute of Chartered Finanacial Analysis, January 1998.

    6. “Investing World Wide VIII- Developments In Global Portfolio Management”, Proceedings, AIMR,

    September 1997.

    7. Peavy III, J.W., “Managing Emerging Market Portfolios: An Overview,” ICFA Continuing Education,

    AIMR, 1994.

    8. Paulson-Ellis, J., “Introducing Emerging Markets,” Proceedings of Managing Emerging Market

    Portfolios Seminar, ICFA Continuing Education, AIMR, 1994.

    9. Davis, L.H., “Top-Down Investing in Emerging Markets,” Proceedings of Managing Emerging

    Market Portfolios Seminar, ICFA Continuing Education, AIMR, 1994.

    10. Wagener, S.B., “Bottom-Up Investing in Emerging Markets,” Proceedings of Managing Emerging

    Market Portfolios Seminar, ICFA Continuing Education, AIMR, 1994.

    11. Krueger, D.M. “Valuation Techniques for Emerging Market Securities,” Proceedings of Managing

    Emerging Market Portfolios Seminar, ICFA Continuing Education, AIMR, 1994.

    12. Quach, M. “Style Investing Implications for the Global Emerging Markets,” Emerging Markets

    Quarterly, Fall 1998.

    13. Madden, M.H, Bonnell, R., “The Opportunity in Emerging Asia’s Recovery,” Emerging Markets

    Quarterly, Fall 1998.

    14. Barry, C.B., Rodriguez, M., “Investing in Latin American Equity Markets,” Emerging Markets

    Quarterly, Fall 1998.

    15. Hwang, S., Satchell, S.,“ “Evaluation of Mutual Fund Performance in Emerging Markets,” Emerging

    Markets Quarterly, Fall 1998.

    16. Equity Research and Valuation Techniques, AIMR, ICFA Continuing Education Series, Pub. No.

    980103, May 1998, 68 pages. This proceedings looks at the tried-and-true valuation and research

    methodologies from a new perspective and reviews some of the new methodologies from a practical

    standpoint. At the heart of the discussions is the notion that analysts and investors must use not only

    their analytical skills but also their creative skills to determine whether a stock is fairly priced.

    (Presentations by B. Kemp Dolliver, CFA; Alfred G. Jackson, CFA; Martin L. Leibowitz; Thomas A.

    Martin, Jr., CFA; Patrick O’Donnell; James A. Ohlson; Fred H. Speece, Jr., CFA; and Timothy J.

    Timura, CFA. Edited by Jan R. Squires, CFA.)

    17. Michaud, Richard, Investment Styles, Market Anomalies, and Global Stock Selection, AIMR, Pub. No.

    988004, Fall 1998. This monograph focuses on global factorreturn relationships for institutional

    equity management and style analysis. The author uses a new global factorreturn equity database,

    defined in 1990 and allowed to evolve over time, that was designed to avoid incurring some of the

    common critiques of market anomaly studies. The framework and data the author presents are intended

    to enhance investor/manager understanding of vital global equity investment issues.

    18. Alternative Investing, AIMR, ICFA Continuing Education Series, Pub. No. 980105 • 105 pages, 1998.

    Historically, alternative investing has produced high returns and provided outstanding diversification

    benefits. It can also be very risky. In this proceedings, the authors stress that knowledge is the

    investor’s most important tool for successful investing in this area. (Presentations by Christopher B.

    Barry; Charles G. Froland, CFA; Frank E. Helsom, CFA; Bruce I. Jacobs; Ernest K. Jacquet; Donald

    M. Krueger, CFA; Scott L. Lummer, CFA; Barbara Lynch; Paul F. McKean, Jr., CFA; Henry G. Robin,

    CFA; and David Steyn.)


     Table of Contents

    Reilly/Brown Text Book

    I. The Investment Background

    1. The Investment Setting

    2. The Asset Allocation Decision

    3. Selecting Investments in a Global Market

    4. Organization and Functioning of Securities Markets

    5. Security Market Indicator Series

    6. Sources of Information on Global Investments II. Developments in Investment Theory

    7. Efficient Capital Markets

    8. An Introduction to Portfolio Management

    9. An Introduction to Asset Pricing Models

    10. Extensions and Testing of Asset Pricing Models

    11. An Introduction to Derivative Markets and Securities III. Valuation Principles and Practices

    12. Analysis of Financial Statements

    13. Introduction to Security Valuation

    14. An Analysis of Alternative Economies and Security Markets: The Global Asset Allocation


    IV. Analysis and Management of Bonds

    15. Bond Fundamentals

    16. The Valuation of Bonds

    17. Bond Portfolio Management Strategies V. Analysis and Management of Common Stock

    18. Stock Market Analysis

    19. Industry Analysis

    20. Company and Stock Analysis

    21. Technical Analysis

    22. Equity Portfolio Management

    VI. Derivative Security Analysis

    23. Forwards and Futures Contracts

    24. Option Contracts

    25. Swap Contracts, Convertible Securities, and Other Embedded Derivatives VII. Analysis of Alternative Assets and Portfolio Performance

    26. Investment Companies


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