CFA – 12.

Portfolio Management

Overview
- Mutual funds
o Open-end (more common) – priced at NAV (net asset value)
o Closed-end – priced at discount/premium to NAV
- Exchange traded funds (ETF)
o Price of ETF may deviate from NAV
o Lower expenses for ETFs, but higher brokerage costs
o ETFs are constantly traded while mutual funds are purchased and redeemed at the
same time at close of business
o Investors can short sell or buy ETF shares on margin
o ETFs do not have capital gain distribution while mutual funds have
o ETFs have dividend distribution, while mutual funds usually reinvest them

Risk Management
- Risk is more easily controlled and managed than return
- Risk management framework
o Risk governance
 Top-level foundation for company
 To delegate to a risk management committee, along with a chief risk officer, at
the operational level
o Risk identification and measurement
 Quantitative and qualitative assessment of risks
 Financial risks
 Market risk
 Credit risk/default risk/counterparty risk
 Liquidity risk
o Risk mitigation
 Active monitoring and adjusting of risk exposures
 Risk modification
 Risk avoidance
 Risk acceptance (diversification, self-insurance: e.g. set up reserve fund)
 Risk transfer (insurance)
 Risk shifting (derivative)
st
o 1 : Risk tolerance – determine risk appetite and risk drivers
 Depend on ability to respond to adverse events
o 2nd: Risk budgeting – to align risk exposure to risk tolerance, by quantifying tolerable
risks using specific metrics to construct portfolio
o 3rd: Risk exposures – to measure the resulting risk exposures and compare against
risk tolerance

Portfolio Risk and Return

- Two-fund separation theorem
o All investors will hold the same combination of a risk-free asset and an optimal risky
portfolio (zero correlation)
- Utility

- Minimum Variance Frontier (MVF) and Efficient Frontier (EF/MVF)

- Capital Allocation Line (CAL)
- Capital Asset Pricing Model (CAPM)

o Beta risk – systematic risk

 Market portfolio: beta = 1

 Risk-free asset: beta = 0
 Uncorrelated with market portfolio: beta = 0
o Security Market Line (SML)
 Intercept – risk-free rate
 Slope – market risk premium
- Return Generating Model
o Security Characteristic Line (SCL)
 Intercept – alpha
 Slope – beta
- Performance evaluation
o Sharpe Ratio

o M-Squared (M2) – identical ranking as Sharpe Ratio

o Treynor ratio – improve Sharpe Ratio

o Jensen’s Alpha (excess return)