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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Sprache: Englisch
A career's worth of portfolio management knowledge in one thorough, efficient guide Portfolio Management is an authoritative guide for those who wish to manage money professionally. This invaluable resource presents effective portfolio management practices supported by their underlying theory, providing the tools and instruction required to meet investor objectives and deliver superior performance. Highlighting a practitioner's view of portfolio management, this guide offers real-world perspective on investment processes, portfolio decision making, and the business of managing money for real clients. Real world examples and detailed test cases--supported by sophisticated Excel templates and true client situations--illustrate real investment scenarios and provide insight into the factors separating success from failure. The book is an ideal textbook for courses in advanced investments, portfolio management or applied capital markets finance. It is also a useful tool for practitioners who seek hands-on learning of advanced portfolio techniques. Managing other people's money is a challenging and ever-evolving business. Investment professionals must keep pace with the current market environment to effectively manage their client's assets while students require a foundation built on the most relevant, up-to-date information and techniques. This invaluable resource allows readers to: * Learn and apply advanced multi-period portfolio methods to all major asset classes. * Design, test, and implement investment processes. * Win and keep client mandates. * Grasp the theoretical foundations of major investment tools Teaching and learning aids include: * Easy-to-use Excel templates with immediately accessible tools. * Accessible PowerPoint slides, sample exam and quiz questions and sample syllabi * Video lectures Proliferation of mathematics in economics, growing sophistication of investors, and rising competition in the industry requires advanced training of investment professionals. Portfolio Management provides expert guidance to this increasingly complex field, covering the important advancements in theory and intricacies of practice.
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Veröffentlichungsjahr: 2019
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Table of Contents
Cover
About the Authors
Acknowledgments
Preface
SUPPLEMENTS
ENDNOTE
CHAPTER 1: Introduction
1.1 INTRODUCTION TO THE INVESTMENT INDUSTRY
1.2 WHAT IS A PORTFOLIO MANAGER?
1.3 WHAT INVESTMENT PROBLEMS DO PORTFOLIO MANAGERS SEEK TO SOLVE?
1.4 SPECTRUM OF PORTFOLIO MANAGERS
1.5 LAYOUT OF THIS BOOK
PROBLEMS
ENDNOTES
CHAPTER 2: Client Objectives for Diversified Portfolios
2.1 INTRODUCTION
2.2 DEFINITIONS OF RISK
2.3 THE PORTFOLIO MANAGEMENT PROCESS AND THE INVESTMENT POLICY STATEMENT
2.4 INSTITUTIONAL INVESTORS
2.5 INDIVIDUAL INVESTORS
2.6 ASSET CLASS PORTFOLIOS
SUMMARY
PROBLEMS
ENDNOTES
CHAPTER 3: Asset Allocation: The Mean - Variance Framework
3.1 INTRODUCTION: MOTIVATION OF THE MEAN–VARIANCE APPROACH TO ASSET ALLOCATION
3.2 THEORY: OUTLINE OF THE MEAN–VARIANCE FRAMEWORK
3.3 PRACTICE: SOLUTION OF STYLIZED PROBLEMS USING THE MEAN–VARIANCE FRAMEWORK
SUMMARY
PROBLEMS
APPENDIX 1: RETURNS, COMPOUNDING, AND SAMPLE STATISTICS
APPENDIX 2: OPTIMIZATION
APPENDIX 3: NOTATION
ENDNOTES
CHAPTER 4: Asset Allocation Inputs
4.1 SENSITIVITY OF THE MEAN–VARIANCE MODEL TO INPUTS
4.2 CONSTANT INVESTMENT OPPORTUNITIES
4.3 TIME-VARYING INVESTMENT OPPORTUNITIES
SUMMARY
PROBLEMS
APPENDIX: MIXED ESTIMATION WITH MULTIPLE ASSETS
ENDNOTES
CHAPTER 5: Advanced Topics in Asset Allocation
5.1 INTRODUCTION
5.2 HORIZON EFFECTS IN THE M-V FRAMEWORK
5.3 DYNAMIC PROGRAMMING
5.4 SIMULATION
5.5 ASSET ALLOCATION WITH ACTIVE MANAGERS
5.6 PORTFOLIO INSURANCE
SUMMARY
PROBLEMS
APPENDIX 1: THE ESTIMATED VAR1 MODEL
APPENDIX 2: DP SOLUTION OF THE MEAN REVERSION MODEL
ENDNOTES
CHAPTER 6: The Investment Management Process
6.1 INTRODUCTION
6.2 THE EFFICIENT MARKET HYPOTHESIS (EMH)
6.3 GENERAL DISCUSSION OF INVESTMENT STRATEGIES
6.4 THE FIVE KEY ELEMENTS OF THE INVESTMENT PROCESS
6.5 THE IMPORTANCE OF QUALITY CONTROL AND OTHER RECOMMENDATIONS
6.6 A SAMPLE INVESTMENT STRATEGY: THE SRY MODEL
SUMMARY
PROBLEMS
ENDNOTES
CHAPTER 7: Introduction to Equity Portfolio Investing: The Investor's View
7.1 INTRODUCTION
7.2 EQUITY STRATEGIES
7.3 SELECTING THE EQUITY MIX
7.4 ALTERNATIVE EQUITY MIXES
7.5 THE EQUITY MANAGEMENT BUSINESS
7.6 IMPLEMENTING THE EQUITY MIX
7.7 EQUITY PORTFOLIO INVESTMENT OBJECTIVES
SUMMARY
PROBLEMS
ENDNOTES
CHAPTER 8: Equity Portfolio Construction
8.1 INTRODUCTION
8.2 PASSIVE VERSUS ACTIVE MANAGEMENT
8.3 PASSIVE PORTFOLIO CONSTRUCTION
8.4 GOALS FOR ACTIVE MANAGEMENT
8.5 SECTOR MANAGEMENT
8.6 STYLE AND SECTOR MANAGEMENT
8.7 IDENTIFYING STYLE
8.8 SAMPLE ACTIVE PORTFOLIO
SUMMARY
PROBLEMS
ENDNOTES
CHAPTER 9: Fixed-Income Management
9.1 INTRODUCTION
9.2 FIXED-INCOME MARKETS, INSTRUMENTS, AND CONCEPTS
9.3 FIXED-INCOME MANDATES
9.4 PASSIVE MANAGEMENT
9.5 ACTIVE MANAGEMENT
9.6 STRUCTURED PORTFOLIOS
SUMMARY
PROBLEMS
ENDNOTES
CHAPTER 10: Global Investing
10.1 INTRODUCTION
10.2 INVESTING WITH A GLOBAL PERSPECTIVE
10.3 GLOBAL INVESTMENT OPPORTUNITIES
10.4 THE IMPACT OF CURRENCY
10.5 INTERNATIONAL DIVERSIFICATION: FAILURE TO DELIVER?
10.6 IMPLICATIONS OF GLOBALIZATION
10.7 CURRENCY OVERLAYS: INCENTIVE-COMPATIBLE PERFORMANCE EVALUATION
SUMMARY
PROBLEMS
ENDNOTES
CHAPTER 11: Alternative Investment Classes
11.1 INTRODUCTION
11.2 HEDGE FUNDS
11.3 VENTURE CAPITAL AND PRIVATE EQUITY
11.4 REAL ESTATE
11.5 COMMODITIES
11.6 ALTERNATIVES MANAGER SELECTION
11.7 ALLOCATING ASSETS INCLUDING ALTERNATIVES
SUMMARY
PROBLEMS
APPENDIX: SOURCES FOR RETURN SERIES
ENDNOTES
CHAPTER 12: Portfolio Management Through Time: Taxes and Transaction Costs
12.1 INTRODUCTION
12.2 PERFORMANCE SHORTFALL
12.3 PORTFOLIO ADJUSTMENTS WITHOUT TAXES OR COSTS
12.4 TRANSACTION COSTS
12.5 TAXATION OF INVESTMENT RETURNS IN THE UNITED STATES
12.6 STRATEGIES TO REDUCE INDIVIDUAL INVESTOR TAXES
12.7 TAX MANAGING A PORTFOLIO OF SECURITIES
SUMMARY
PROBLEMS
ENDNOTES
CHAPTER 13: Performance Measurement and Attribution
13.1 INTRODUCTION
13.2 PERFORMANCE MEASUREMENT
13.3 PERFORMANCE ATTRIBUTION
13.4 PERFORMANCE APPRAISAL: INCENTIVE EFFECTS
SUMMARY
PROBLEMS
APPENDIX: CALCULATION OF RISK MEASURES
ENDNOTES
CHAPTER 14: Incentives, Ethics, and Policy
14.1 INTRODUCTION
14.2 THE INVESTMENT COMPANY BUSINESS MODEL
14.3 INCENTIVES FOR BUSINESSPEOPLE AND PORTFOLIO MANAGERS
14.4 ETHICAL SITUATIONS
14.5 INDUSTRY GUIDELINES FOR GOOD BUSINESS PRACTICES
14.6 INTERNAL COMPANY POLICIES TO PROTECT THE FRANCHISE
14.7 EFFECTIVE MANAGER AND ANALYST COMPENSATION POLICIES
SUMMARY
PROBLEMS
APPENDIX: SAMPLE LIST OF INVESTMENT POLICIES
ENDNOTES
CHAPTER 15: Investor and Client Behavior
15.1 INTRODUCTION
15.2 THEORY AND OBSERVATIONS OF HUMAN BEHAVIOR
15.3 IMPLICATIONS FOR ACTIVE MANAGEMENT
15.4 IMPLICATIONS FOR SETTING INVESTMENT POLICY
15.5 IMPLICATIONS FOR MANAGER SELECTION
SUMMARY
PROBLEMS
ENDNOTES
CHAPTER 16: Managing Client Relations
16.1 INTRODUCTION
16.2 GENERAL RECOMMENDATIONS FOR CLIENT MANAGEMENT
16.3 MEETING CLIENT NEEDS
16.4 MANAGER SELECTION PROCESS
16.5 SECURING NEW CLIENTS
16.6 RETAINING CLIENTS
16.7 CASE STUDY
SUMMARY
PROBLEMS
ENDNOTES
Sample Cases
Jerry W.
PRIVATE WEALTH CASE: DESIGNING AN INVESTMENT PLAN FOR JERRY W.
APPENDICES
INVESTOR QUESTIONNAIRE
ENDNOTES
MSSI
DEFINED BENEFIT PLAN CASE: DESIGNING THE INVESTMENT STRUCTURE FOR MSSI CORPORATION'S DEFINED BENEFIT PLAN
McClain Capital
DEFINED CONTRIBUTION PLAN CASE: DESIGNING A CUSTOM DEFINED CONTRIBUTION PLAN
The Fairbanks Fund
FUND CASE: THE FAIRBANKS SMALL-CAP U.S. EQUITY FUND
WHITTIER WEALTH MANAGEMENT: FAIRBANKS SMALL-CAP EQUITY FUND
Glossary
References
Index
End User License Agreement
List of Tables
Chapter 2
EXHIBIT 2.3 Ten Largest U.S. Fou ndations
EXHIBIT 2.4 Ten Largest U.S. Endowments
Chapter 3
EXHIBIT 3.1 Historical Correlations: Monthly Gross Returns, 45 Years Ending...
EXHIBIT 3.2 Historical Returns: Annualized Gross, Ending 12/31/2016
EXHIBIT 3.3 Historical Standard Deviation: Annual Gross Returns, Ending...
Chapter 4
EXHIBIT 4.1 95% Confidence Intervals for Expected Return
EXHIBIT 4.2 95% Confidence Intervals for the Sample Standard Deviation
EXHIBIT 4.3 James–Stein Estimation: Monthly Data 1985–2016
EXHIBIT 4.4 Decomposition of S&P 500 Returns: Log Returns 1946–2016
EXHIBIT 4.5 Implied Views
EXHIBIT 4.7 Factor Model Exposures and Risk Premiums
EXHIBIT 4.9 Election Cycle for S&P 500: Log Returns 1929–2016
EXHIBIT 4.10 Models of S&P 500: Annual Log Returns 1946–2016
Chapter 5
EXHIBIT 5.8 Current Return versus Future Opportunities
EXHIBIT 5.12 Impact of Cash Flows and Alternative Probability Distributions
EXHIBIT 5.14 Mean-Lower Partial Moment Optimization
EXHIBIT 5.15 Distribution of Portfolios from Statistically Equivalent Inputs
Chapter 6
EXHIBIT 6.1 The Investment Process: Signal-Based Decision Making
EXHIBIT 6.2 Issues to Explore When Designing a Paper Portfolio
EXHIBIT 6.3 Implementation: Liquidity, Value Added, and Capacity
EXHIBIT 6.4 Feedback: Performance at Each Step
EXHIBIT 6.6 Cycle of Asset Price Levels
EXHIBIT 6.8 Tactical Asset Allocation Signal
EXHIBIT 6.10 Sample Market Characteristics: Stock (SPY) and Bond (AGG) ETFs
EXHIBIT 6.11 Representative Bid–Ask Spread and Market Impact Data: Stoc...
EXHIBIT 6.12 Representative Transaction Cost Data: SPY ETF Sample One-Way...
EXHIBIT 6.13 Simulation Results: Tactical Asset Allocation Strategy...
Chapter 7
EXHIBIT 7.1 Russell Equity Style Indexes
EXHIBIT 7.2 Historical Correlations: Gross Monthly Russell and EAFE Equity...
EXHIBIT 7.3 Annualized Historical Gross Returns: Russell and EAFE Equity Inde...
EXHIBIT 7.4 Historical Standard Deviation, Gross Annual Returns: Russell and...
EXHIBIT 7.5 Market Valuations: Percentages of Equity Market—U.S. Equity...
EXHIBIT 7.8 Mean–Variance Alternative Portfolios: Equity Asset Classes
EXHIBIT 7.9 Equity Asset Class Log Return Expectations (α): Historical...
EXHIBIT 7.10 Optimal Equity Mix (Maximized Risk–Return Trade-Off) Using...
EXHIBIT 7.11 Stress Test Results: Alternative Equity Mixes (Described in Exhi...
EXHIBIT 7.13 Comparing Portfolio Characteristics
EXHIBIT 7.14 Sample Equity Mix: Mutual Fund
EXHIBIT 7.15 Sample Equity Mix: Institutional Fund
Chapter 8
EXHIBIT 8.5 Lipper's U.S. Equity Mutual Fund Classifications
EXHIBIT 8.6 Sample Weighting Algorithm for a 25 Percent Weighted Sector
EXHIBIT 8.8 Sample Portfolio Descriptive Statistics
EXHIBIT 8.10 Sample Portfolio Listing: First Step
Chapter 9
EXHIBIT 9.2 Bond Market Statistics: Bloomberg Barclays Indexes, 12/29/2017
EXHIBIT 9.3 Correlation of Stocks and Bonds: Monthly Log Returns, January...
EXHIBIT 9.4 Stock and Bond Correlations with Realized Inflation: All Five-Yea...
EXHIBIT 9.5 Serial Correlation of Returns: January 1926–May 2017
EXHIBIT 9.7 Sample Fixed-Income Mandate: Teachers Retirement System of Texas
EXHIBIT 9.8 Log Excess Returns on Bloomberg Barclays Corporate Indexes versus...
Chapter 10
EXHIBIT 10.2 Sector Composition: Industry Groups and Concentration Across...
EXHIBIT 10.4 Global Equity Markets: January 1996–March 2017
EXHIBIT 10.6 Composition of the Global Investment-Grade Bond Market (March...
EXHIBIT 10.7 Global Government Bond Markets: January 1998–April 2018
EXHIBIT 10.8 Returns with Alternative Currency Strategies
EXHIBIT 10.9 Hedging a Risky Asset
EXHIBIT 10.10 Conditional Correlation of Extreme Returns: Two Assets, 500...
EXHIBIT 10.11 Diversification Benefits of International Equities: Structured...
EXHIBIT 10.12 The Principle of Invariance—Equivalent Positions (Each...
EXHIBIT 10.13 Conflict-of-Interest Example
Chapter 11
EXHIBIT 11.3 Hedge Fund Styles and Strategies
EXHIBIT 11.4 Hedge Fund Return Summary Statistics (Jan-98 to Jun-18)
EXHIBIT 11.6 Comparison of Annualized PE and VC Standard Deviations (Quarter...
EXHIBIT 11.7 Estimate of Relationship Between VC and NASDAQ Returns
EXHIBIT 11.8 Return and Volatility Results of Modeled VC Data
EXHIBIT 11.10 Comparison of Real Estate Return Standard Deviations
EXHIBIT 11.11 Sample List of Commodities, Traded on U.S. Futures Exchanges
EXHIBIT 11.12 Performance Characteristics of Commodity Futures
EXHIBIT 11.13 Massachusetts Pension Reserves Investment Trust Fund
EXHIBIT 11.14 Return Correlations of Common and Alternatives Asset Classes...
EXHIBIT 11.15 Sample Statistics of Monthly Returns on Common and Alternative...
EXHIBIT 11.16 Yale University Endowment Asset Allocation
EXHIBIT 11.17 Historical Return Risk Analysis of Yale Endowment Allocation
EXHIBIT 11.18 Value at Risk Analysis of Yale Endowment Allocation
EXHIBIT 11.19 LPM Optimal Portfolio versus Yale Portfolio
EXHIBIT 11.20 2008 Reported and Modeled Returns
Chapter 12
EXHIBIT 12.2 Sources of Performance Shortfall
EXHIBIT 12.3 Historic Trading Losses
EXHIBIT 12.5 Representative Volume, Bid–Ask Spread, and Market Impact...
EXHIBIT 12.6 Sample One-Way $10 Million Trade in SPY, Price of $273
EXHIBIT 12.11 After-Tax Returns of Funds with Different Turnover Levels: Tota...
Chapter 13
EXHIBIT 13.1 The Impact of Flows
EXHIBIT 13.2 Impact of Pricing Errors and Positive Flows
EXHIBIT 13.3 Impact of Pricing Errors and Negative Flows
EXHIBIT 13.6 Unconstrained Style Analysis
EXHIBIT 13.7 Constrained Style Analysis
Chapter 14
EXHIBIT 14.1 Revenue and Expense Comparison, T. Rowe Price Group, 2017
EXHIBIT 14.2 Profit and Investment Performance Comparison
Chapter 15
EXHIBIT 15.1 List of Behavioral Finance Terms
EXHIBIT 15.2 Return Trend and Reversal Behavior in the Stock Market
Chapter 16
EXHIBIT 16.1 Summary of Product Offerings to Individual Investor Market
EXHIBIT 16.2 Subsequent Levels of Consistency and Return Differences Between...
EXHIBIT 16.4 Layout of Sales Presentation
EXHIBIT 16.8 Key Components of a Portfolio Review and Their Objectives
List of Illustrations
Chapter 1
EXHIBIT 1.1 Total Worldwide Assets Under Management
EXHIBIT 1.2 Profile of Portfolio Managers by Rigor and Level of Specialization
Chapter 2
EXHIBIT 2.5 Smoothing Real Spending: An Example
EXHIBIT 2.6 Participation in DB and DC Plans: Percent of U.S. Private Sector (Al...
EXHIBIT 2.7 Plan Type U.S. Total Retirement Market Assets ($ trillion)
EXHIBIT 2.10 DB Plan Benefit Payments
EXHIBIT 2.11 Example of DB Plan Liability Evolution Over Time
EXHIBIT 2.12 Defined Contribution Assets
EXHIBIT 2.15 401(k) Allocations by Age Group (2015)
EXHIBIT 2.16 How $25 million+ Investors Created Their Wealth
EXHIBIT 2.17 Bailard, Biehl, and Kaiser Psychological Needs Model
EXHIBIT 2.18 Total Client Assets
Chapter 3
EXHIBIT 3.4 Risk-Averse Utility
EXHIBIT 3.5 Expected Utility and Risk Aversion
EXHIBIT 3.6 M-V Frontier, Two-Asset Portfolios of Varying Weights
EXHIBIT 3.7 M-V Frontier for Excel Outbox
EXHIBIT 3.8 Horizon Return Confidence Interval
Chapter 4
EXHIBIT 4.6 Factor Contributions to Risk (%)
EXHIBIT 4.8 Mixed Estimation versus Ratio of Error Variances
EXHIBIT 4.11 Detrended 5-Year Log Returns
EXHIBIT 4.12 Risk vs. Horizon
Chapter 5
EXHIBIT 5.1 Risk Aversion: Alternative Horizon Profile Functions f(T)
EXHIBIT 5.2 Stock Allocation versus Risk Tolerance [1/Risk Aversion]
EXHIBIT 5.3 Annualized Risk versus Horizon: Stocks and Bills
EXHIBIT 5.4 Risk versus Horizon: Bonds and Bills
EXHIBIT 5.5 Correlation of Nominal Returns Over Different Horizons
EXHIBIT 5.6 Correlation of Real Returns Over Different Horizons
EXHIBIT 5.7 Recursive Shortfall
EXHIBIT 5.9 Mean Reversion Model: Impact of Risk Premium on Stock Allocation
EXHIBIT 5.10 Horizon Impact of Mean Reversion: Stocks as a Fraction of Excess Wealth
EXHIBIT 5.11 Horizon Impact of Mean Reversion: Stocks as a Fraction of Wealth
EXHIBIT 5.13 Deviations from Normal Distribution
EXHIBIT 5.17 Payoff Profile for Portfolio Insurance
Chapter 6
EXHIBIT 6.5 Stock Returns versus Bond Returns: 12-Month Relative Returns, 1976–2...
EXHIBIT 6.7 Relative Valuation of Stocks and Bonds, 1976–2016
EXHIBIT 6.9 Relative Yield and Signal Band, 1976–2016 (3-year Moving Average and...
EXHIBIT 6.14 Simulation Results: Tactical Asset Allocation Strategy vs. 50/50 Be...
Chapter 7
EXHIBIT 7.6 Growth, Value, and GDP Changes
EXHIBIT 7.7 Mean–Variance Model: Equity Asset Classes
EXHIBIT 7.12 Mutual Fund Structure
EXHIBIT 7.16 Sample Investment Mix of Active Mutual Funds
EXHIBIT 7.18 Sample Process Chart
Chapter 8
EXHIBIT 8.1 Performance of Active Mutual Funds versus Market Indexes, 1989–2016
EXHIBIT 8.2 Performance of Active Small-Cap Growth and Value Equity Funds
EXHIBIT 8.4 Weight Distribution of Securities in the S&P 400
EXHIBIT 8.11 Final Portfolio Descriptive Statistics
Chapter 9
EXHIBIT 9.1 Composition of the U.S. Taxable Bond Market
EXHIBIT 9.9 Intermediate Corporate Spread Trading Opportunities: Bloomberg Barcl...
Chapter 10
EXHIBIT 10.1 Sector Breakdown of the iShares MSCI All-Country World Index ET...
EXHIBIT 10.3 Industry Concentration of 21 Developed Equity Markets: iShares MSCI...
EXHIBIT 10.5 International Diversification: Impact of Correlation Between Foreig...
Chapter 11
EXHIBIT 11.1 Global Assets Under Management ($ trillion), 2014
EXHIBIT 11.2 Hedge Fund Assets Under Management, 2000–2018
EXHIBIT 11.5 Private Equity Funds: Number Launched and Aggregate Capital Raised
EXHIBIT 11.9 Growth of REITs
Chapter 12
EXHIBIT 12.1 Backtest vs. Live Sample Performance
EXHIBIT 12.4 Prototypical Rebalancing Strategies
EXHIBIT 12.7 Trading with Fixed Transaction Costs
EXHIBIT 12.8 Trading with Proportional Transaction Costs
EXHIBIT 12.9 Two Assets with Proportional Costs
EXHIBIT 12.10 Trading with Increasing Transaction Costs
Chapter 13
EXHIBIT 13.4 The Security Market Line and Jensen's Alpha
EXHIBIT 13.5 The Security Market Line and the Treynor Ratio
Chapter 15
EXHIBIT 15.3 Morningstar Fund Screener
Chapter 16
EXHIBIT 16.3 Typical Institutional Hiring Process
EXHIBIT 16.5 Sample Investment Process Chart
EXHIBIT 16.6 Sample Mutual Fund Communication Materials
EXHIBIT 16.7 Sample Communication Materials Following a Period of Poor Performan...
EXHIBIT 16.9 Distribution of 12-Month Active Returns and Subsequent Active Retur...
Guide
Cover
Table of Contents
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Portfolio Management: Theory and Practice
Second Edition
SCOTT D. STEWART
CHRISTOPHER D. PIROS
JEFFREY C. HEISLER
Copyright © 2019 by Scott D. Stewart, Christopher D. Piros, and Jeffrey C. Heisler. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.1e (2011, McGraw-Hill Education).
Published simultaneously in Canada.
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Library of Congress Cataloging-in-Publication Data
Names: Stewart, Scott Dudley, 1958– author. | Piros, Christopher Dixon, author. | Heisler, Jeffrey, 1959– author.
Title: Portfolio management / Scott D. Stewart, Christopher D. Piros, Jeffrey C. Heisler.
Other titles: Running money
Description: Second edition. | Hoboken, New Jersey: John Wiley & Sons, Inc., [2019] | Earlier edition published as: Running money : professional portfolio management. | Includes bibliographical references and index. | Identifiers: LCCN 2018060331 (print) | LCCN 2019001679 (ebook) | ISBN 9781119397434 (ePub) | ISBN 9781119397441 (ePDF) | ISBN 9781119397410 (hardcover)
Subjects: LCSH: Portfolio management. | Investments.
Classification: LCC HG4529.5 (ebook) | LCC HG4529.5 .S72 2019 (print) | DDC 332.6—dc23
LC record available at https://lccn.loc.gov/2018060331
Cover Image: © Enrique Ramos Lpez/EyeEm/Getty ImagesCover Design: Wiley
To my wife, Pam, and our children, John, Chris, Kate, and Anne.
—SDS
To my wife, Chris, and our sons, Matt, Drew, and Daniel.
—CDP
To Kaisa, Linda, Charles, Philip, Thomas, Peter, Jillian, and Michael.
—JCH
About the Authors
Scott Stewart is a clinical professor of Finance and Accounting at Cornell University's S. C. Johnson Graduate School of Management and is faculty co-director of Cornell's Parker Center for Investment Research. Prior to that, he was a research associate professor at Boston University's School of Management and faculty director of its graduate program in Investment Management. From 1985 to 2001, Dr. Stewart managed global long and long-short equity, fixed-income, and asset allocation portfolios for Fidelity Investments and State Street Asset Management (now State Street Global Advisors). As a fund manager, he earned recognition for superior investment performance by Micropal, The Wall Street Journal, and Barron's. At Fidelity, he founded the $45 billion Structured Investments Group, managed varied funds including the Fidelity Freedom Funds®, and was senior advisor to equity research. Dr. Stewart's research interests include portfolio management, institutional investors, equity valuation, and investment technology. His work has been published in The Financial Analysts Journal and The Journal of Portfolio Management and he authored Manager Selection. He earned his MBA and PhD in Finance at Cornell University, and is a CFA® charterholder.
Christopher Piros has been an investment practitioner and educator for more than 30 years. As managing director of investment strategy for Hawthorn, PNC Family Wealth, and PNC Institutional Asset Management he led overall strategic and tactical guidance of client portfolios and oversaw the evolution of investment processes. At CFA Institute he was jointly responsible for developing the curriculum underlying the Chartered Financial Analyst® designation. Previously, he established and led the discretionary portfolio management activities of Prudential Investments LLC, the wealth management services arm of Prudential Financial. Earlier he was a global fixed income portfolio manager and head of fixed income quantitative analysis at MFS Investment Management. Dr. Piros began his career on the finance faculty of Duke University's Fuqua School of Business. More recently he has been an adjunct faculty member at Boston University and Reykjavik University. He co-edited Economics for Investment Decision-Makers. His research has been published in academic and practitioner journals and books. Dr. Piros, a CFA® charterholder, earned his PhD in Economics at Harvard University.
Jeffrey Heisler is a managing director at TwinFocus Capital Partners, a boutique multifamily office for global ultra-high-net-worth families, entrepreneurs, and professional investors. Previously, he was the market strategist at The Colony Group, an independent wealth management firm. In previous roles he served as the chief risk officer at Venus Capital Management, an investment advisor that specialized in relative value trading strategies in emerging markets, and as a portfolio manager and senior analyst for Gottex Fund Management, a fund-of-hedge-funds manager. He started his professional career as an engineer in multiple capacities with IBM. Dr. Heisler was an assistant professor in the Finance and Economics Department at Boston University Questrom School of Management, and the founding faculty director of its graduate program in investment management. His research on the behavior of individual and institutional investors has been published in both academic and practitioner journals. He earned his MBA at the University of Chicago and his PhD in finance at New York University. He is also a CFA® charterholder.
Acknowledgments
This book would not have been possible without the academic training provided to us by many dedicated teachers. We'd especially like to thank our doctoral thesis advisors, Stephen Figlewski, Benjamin Friedman, and Seymour Smidt, for their gifts of time, encouragement, and thoughtful advice. We'd also like to recognize several professors who challenged and guided us in our academic careers: Fischer Black, David Connors, Nicholas Economides, Edwin Elton, Robert Jarrow, Jarl Kallberg, John Lintner, Terry Marsh, Robert Merton, William Silber, and L. Joseph Thomas.
The practical experience we received in the investment industry helped us make this book unique. We thank all our colleagues at Colony, CFA Institute, Fidelity, Gottex, MFS, PNC, Prudential, State Street, TwinFocus, and Venus for their support and good ideas over the years. Space does not permit listing all the individuals with whom we have shared the pursuit of superior investment performance for our clients. We would be remiss, however, if we did not acknowledge Amanda Agati, Steve Bryant, Ed Campbell, Ren Cheng, Jennifer Godfrey, Richard Hawkins, Timothy Heffernan, Cesar Hernandez, Stephen Horan, Paul Karger, Wesley Karger, Dick Kazarian, Richard Leibovitch, Liliana Lopez, Robert Macdonald, Kevin Maloney, Jeff Mills, Les Nanberg, William Nemerever, John Pantekidis, Marcus Perl, Jerald Pinto, Wendy Pirie, John Ravalli, Dan Scherman, Robin Stelmach, and Myra Wonisch Tucker.
We also want to thank those who helped with specific sections of the text, including providing data and suggestions to improve chapters, cases, and examples. These include Amanda Agati, Scott Bobek, Richard Hawkins, Ed Heilbron, Dick Kazarian, John O'Reilly, Marcus Perl, Jacques Perold, Bruce Phelps, Jonathan Shelon, and George Walper, as well as the students at Boston University, Cornell, and Reykjavik University who used versions of this text. We are grateful to the following individuals for their thoughtful comments on a much earlier draft of the full manuscript: Honghui Chen, Ji Chen, Douglas Kahl, David Louton, Mbodja Mougone, Zhuoming Peng, Craig G. Rennie, Alex P. Tang, Damir Tokic, and Barbara Wood.
We also wish to thank everyone at Wiley who worked with us to bring the book to fruition. Finally, a special thank-you to our families and friends for their support and patience during the long journey of writing this book; it would not have been possible without them.
Preface
The investment landscape is ever-changing. Today's innovative solution will be taken for granted tomorrow. In writing Portfolio Management: Theory and Practice, our goal is to expose readers to what it is really like to manage money professionally by providing the tools rather than the answers. This book is an ideal text for courses in portfolio management, asset allocation, and advanced or applied investments. We've also found it to be an ideal reference, offering hands-on guidance for practitioners.
Broadly speaking, this book focuses on the business of investment decision making from the perspective of the portfolio manager—that is, from the perspective of the person responsible for delivering investment performance. It reflects our combined professional experience managing multibillion-dollar mandates within and across the major global and domestic asset classes, working with real clients, and solving real investment problems; it also reflects our experience teaching students.
We taught the capstone Portfolio Management course in the graduate programs in Investment Management at Boston University and Reykjavik University for over ten years, and advanced portfolio management courses at Cornell University for five. By the time students took our classes most of them had worked in the industry and were on their way to mastering the CFA Body of KnowledgeTM required of candidates for the CFA® designation. The courses' curricula were designed to embrace and extend that knowledge, to take students to the next level. This text grew from these courses and was refined and improved as successive versions of the material1 were used in our classes and by many other instructors in the Americas, Asia, and EMEA beginning in 2010.
This book aims to build on earlier investment coursework with minimal repetition of standard results. Ideally a student should already have taken a broad investments course that introduces the analysis of equity, fixed income, and derivative securities. The material typically covered in these courses is reviewed only briefly here as needed. In contrast, new and more advanced tools are accorded thorough introduction and development. Prior experience with Microsoft Excel spreadsheets and functions will be helpful because various examples and exercises throughout the book use these tools. Familiarity with introductory quantitative methods is recommended as well.
We believe this book is most effectively used in conjunction with cases, projects, and real-time portfolios requiring hands-on application of the material. Indeed this is how we have taught our courses, and the book was written with this format in mind. This approach is facilitated by customizable Excel spreadsheets that allow students to apply the basic tools immediately and then tailor them to the demands of specific problems.
It is certainly possible to cover all 16 chapters in a single-semester lecture course. In a course with substantial time devoted to cases or projects, however, the instructor may find it advantageous to cover the material more selectively. We believe strongly thatChapters 1, 2, and 14 should be included in every course—Chapters 1 and 2 because they set the stage for subsequent topics, and Chapter 14 because ethical standards are an increasingly important issue in the investment business. In addition to these three chapters, the instructor might consider creating courses around the following modules:
The investment business:
Chapters 3
,
6
,
13
, and
16
These chapters provide a high-level perspective on the major components of the investment business: clients, asset allocation, the investment process, and performance measurement and attribution. They are essential for those who need to understand the investment business but who will not be involved in day-to-day investment decision making.
Managing client relationships:
Chapters 13
,
15
, and
16
These chapters focus on clients: their needs, their expectations, their behavior, how they evaluate performance, and how to manage relationships with them. Virtually everyone involved in professional portfolio management needs to understand this material, but it is especially important for those who will interact directly with clients.
Asset allocation:
Chapters 3
–
15
,
11
, and
12
Asset allocation is a fundamental component of virtually every client's investment problem. Indeed widely cited studies indicate that it accounts for more than 90 percent of long-term performance.
Chapters 3
–
5
start with careful development of basic asset allocation tools and progress to advanced topics, including estimation of inputs, modeling horizon effects, simulation, portable alpha, and portfolio insurance.
Chapter 11
brings in alternative asset classes.
Chapter 12
addresses rebalancing and the impact of transaction costs and taxes. These chapters are essential for anyone whose responsibility encompasses portfolios intended to address clients' broad investment objectives.
Security and asset class portfolio management:
Chapters 6
–
12
Starting with an overview of the investment process (
Chapter 6
), these chapters focus on the job of managing a portfolio of securities within particular asset classes: equities (
Chapters 7
and
8
), fixed income (
Chapter 9
), international (
Chapter 10
), and alternatives (
Chapters 11
).
Chapter 12
addresses rebalancing and the impact of transaction costs and taxes.
Of course these themes are not mutually exclusive. We encourage the instructor to review all the material and select the chapters and sections most pertinent to the course objectives.
Portfolio Management: Theory and Practice includes several features designed to reinforce understanding, connect the material to real-world situations, and enable students to apply the tools presented:
Excel spreadsheets:
Customizable Excel spreadsheets are available online. These spreadsheets allow students to apply the tools immediately. Students can use them as they are presented or tailor them to specific applications.
Excel outboxes:
Text boxes provide step-by-step instructions enabling students to build many of the Excel spreadsheets from scratch. Building the models themselves helps to ensure that the students really understand how they work.
War Story boxes:
Text boxes describe how an investment strategy or product worked—or did not work—in a real situation.
Theory in Practice boxes:
Text boxes link concepts to specific real-world examples, applications, or situations.
End-of-chapter problems:
End-of-chapter problems are designed to check and to reinforce understanding of key concepts. Some of these problems guide students through solving the cases. Others instruct students to expand the spreadsheets introduced in the Excel outboxes.
Real investment cases:
The appendix provides four canonical cases based on real situations involving a high-net-worth individual, a defined benefit pension plan, a defined contribution pension plan, and a small-cap equity fund. The cases are broken into four steps that can be completed as students proceed through the text. The material required to complete the first step, understanding the investor's needs and establishing the investment policy statement, is presented in
Chapters 1
and
2
. Step 2, determining the asset allocation, draws on
Chapters 3
–
5
. Step 3, implementing the investment strategy, draws on the material in
Chapters 6
–
13
. The final step, measuring success, brings together the issues pertaining to performance, ethics, and client relationships addressed in
Chapters 13
–
16
.
This book was conceived to share our investment management and university teaching experience. Writing it has been a lot like being a portfolio manager: always challenging, sometimes frustrating, but ultimately rewarding. We hope the book challenges you and whets your appetite for managing money.
SUPPLEMENTS
The Wiley online resources site, Wiley.com/PortfolioManagement, contains the Excel spreadsheets and additional supplementary content specific to this text. Sample exams, solutions, video lectures, and PowerPoint presentations are available to the instructor in the password-protected instructor's center. As students read the text, they can go online to the student center to download the Excel spreadsheets, and review the supplemental case material.
Case spreadsheets:
Excel spreadsheets give students additional material for analysis of the cases.
Solutions to end-of-chapter problems:
Detailed solutions to the end-of-chapter problems help students confirm their understanding.
Sample final exams:
Prepared by the authors, the sample exams offer multiple-choice and essay questions to fit any instructor's testing needs.
Solutions to sample final exams:
The authors offer detailed suggested solutions for the exams.
PowerPoint presentations:
Prepared by the authors, the PowerPoint presentations offer full-color slides for all 16 chapters to use in a classroom lecture setting. Organized to accompany each chapter, the slides include images, tables, and key points from the text.
Lecture videos:
Prepared by the authors and covering the basics of each chapter, students can view these lectures as a supplement to the readings.
ENDNOTE
1
. An earlier version of this book, entitled
Running Money: Professional Portfolio Management
, was published by McGraw-Hill in 2010. Early versions of
Chapters 3
and
6
were offered by CFA
®
Institute in its continuing education program.
CHAPTER 1Introduction
Chapter Outline
1.1 Introduction to the Investment Industry
1.2 What Is a Portfolio Manager?
1.3 What Investment Problems Do Portfolio Managers Seek to Solve?
1.4 Spectrum of Portfolio Managers
1.5 Layout of This Book
Problems
Endnotes
1.1 INTRODUCTION TO THE INVESTMENT INDUSTRY
The investment business offers the potential for an exciting career. The stakes are high and the competition is keen. Investment firms are paid a management fee to invest other people's money and their clients expect expert care and superior performance. Managing other people's money is a serious endeavor. Individuals entrust their life savings and their dreams for attractive homes, their children's educations, and comfortable retirements. Foundations and endowments hand over responsibility for the assets that support their missions. Corporations delegate management of the funds that will pay future pension benefits for their employees. Successful managers and their clients enjoy very substantial financial rewards, but sustained poor performance can undermine the well-being of the client and leave the manager searching for a new career.
Many bright and hard-working people are attracted to this challenging industry. Since their competitors are working so hard, portfolio managers must always be at their best, and continue to improve their skills and knowledge base. For most portfolio managers, investing is a highly stimulating vocation, requiring constant learning and self-improvement. Clients are demanding, especially when results are disappointing. While considered a stressful job by many people, it is not unheard of for professionals to manage money into their eighties or nineties.1
Portfolio management is becoming increasingly more sophisticated due to the ongoing advancement of theory and the growing complexity of practice, led by a number of trends, including:
Advances in modern portfolio theory.
More complex instruments.
Increased demands for performance.
Increased client sophistication.
Rising retirement costs, and the growing trend toward individual responsibility for those costs.
Dramatic growth in assets under management.
These trends parallel the growing use of mathematics in economics, the improvements in investment education of many savers, and the increasing competitiveness of the industry. Assets controlled by individual investors have grown rapidly. In 2016, just under half of all U.S. households owned stock, but fewer than 14 percent directly owned individual stocks.2 By year-end 2017, U.S.-registered investment company assets under management had expanded to $22.5 trillion from $2.8 trillion in 1995, managed over 16,800 funds, and employed an estimated 178,000 people.3 The global money management business has grown in parallel. Exhibit 1.1 shows that worldwide assets under management have expanded over 2.5× from 2005 to 2017.
Source: Based on data from Pension & Investments.
EXHIBIT 1.1 Total Worldwide Assets Under Management
Portfolio management is based on three key variables: the objective for the investment plan, the initial principal of the investment, and the cumulative total return on that principal. The investment plan, or strategy, is tailored to provide a pattern of expected returns consistent with meeting investment objectives within acceptable levels of risk. This investment strategy should be formed by first evaluating the requirements of the client, including their willingness and ability to take risk, their cash-flow needs, and identifying any constraints, such as legal restrictions. Given the cash flow needs and acceptable expected risk-and-return outcomes, the allocation between broad asset classes is set in coordination with funding and spending policies. Once investment vehicles are selected and the plan is implemented, subsequent performance should be analyzed to determine the strategy's level of success. Ongoing review and adjustment of the portfolio is required to ensure that it continues to meet the client's objectives.
THEORY IN PRACTICE: FAMOUS LAST WORDS—“IT'S DIFFERENT THIS TIME.”
The year 2008 was a terrible one for the markets. The S&P 500 fell nearly 40 percent, high-yield bonds declined over 25 percent, and in December Bernie Madoff admitted to what he claimed was a $50 billion Ponzi scheme. While these numbers are shocking, they are not unprecedented and the reasons behind them are not new. Security values can change drastically, sometimes with surprising speed. Declining values can be a response to peaking long-term market cycles, short-term economic shocks, or the idiosyncratic risk of an individual security.
Market cycles can take months or years to develop and resolve. The dot-com bubble lasted from 1995 to 2001. The March 2000 peak was followed by a 65+ percent multiyear decline in the NASDAQ index as once-lofty earnings growth forecasts failed to materialize. The S&P 500 dropped over 40 percent in 1973 and 1974 as the economy entered a period of stagflation following the boom of the 1960s and the shock of the OPEC oil embargo. Black Monday, October 19, 1987, saw global equity markets fall over 20 percent in the course of a single day. The collapse of Enron destroyed more than $2 billion in employee retirement assets and more than $60 billion in equity market value. While the true cost may never be known, economists at the Federal Reserve of Dallas conservatively estimate the cost of the 2007–09 financial crisis to the U.S. alone was $6–$14 trillion.4
Each of these examples had a different cause and a different time horizon, but in each case the potential portfolio losses were significant. To assist investors, this book outlines the basic—and not so basic—principles of sound portfolio management. These techniques should prepare the investor to weather market swings. The broad themes include:
Creating and following an investment plan to help maintain discipline. Investors often appear driven by fear and greed. The aim should be to avoid panicking when markets sell off suddenly (1974, 1987) and risk missing the potential recovery, or overallocating to hot sectors (the dot-com bubble) or stocks (Enron) and being hurt when the market reverts.
Focus on total return and not yield or cost.
Establishing and following a proper risk management discipline. Diversification and rebalancing of positions help avoid outsized exposures to particular systematic or idiosyncratic risks. Performance measurement and attribution provide insight into the risks and the sources of return for an investment strategy.
Not investing in what you do not understand. In addition to surprisingly good performance that could not be explained, there were additional red flags, such as lack of transparency, in the Enron and Madoff cases.
Behave ethically and insist others do, too.
Although attractive or even positive returns cannot be guaranteed, following the principles of sound portfolio management can improve the likelihood of achieving the investor's long-range goals.
This book presents effective portfolio management practice, not simply portfolio theory. The goal is to provide a primer for people who wish to run money professionally. The book includes the information a serious portfolio manager would learn over a 20-year career—grounded in academic rigor, yet reflecting real business practice and presented in an efficient format. Importantly, this book presents tools to help manage portfolios into the future; that is what a portfolio manager is paid to do. Although the book discusses the value of historical data, it guides the reader to think more about its implications for the future. Simply relying on historical records and relationships is a sure way to disappoint clients.
This is not a cook-book or collection of unrelated essays; the chapters tell a unified story. This book presents techniques that the reader may use to address real situations. A working knowledge of investments including derivatives, securities analysis, and fixed income is assumed, as well as basic proficiency in Excel. Where necessary, the book presents careful development of new tools that typically would not be covered in an MBA curriculum.
1.2 WHAT IS A PORTFOLIO MANAGER?
Investment management firms employ many investment professionals. They include a CEO to manage the business, portfolio managers supported by research analysts, salespeople to help attract and retain clients, and a chief investment officer to supervise the portfolio managers. There are many more people behind the scenes, such as risk officers and accounting professionals, to make sure the money is safe. A portfolio manager may be defined by three characteristics:
Responsible for delivering investment performance.
Full authority to make at least some investment decisions.
Accountable for investment results.
Investment decisions involve setting weights of asset classes, individual securities, or both, to yield desired future investment performance. Full authority means the individual has control over these decisions. For example, portfolio managers do not need the approval of a committee or superior before directing allocation changes. In fact, on more than one occasion portfolio managers have resigned after their full discretion was restricted. A chief investment officer has authority, not over security selection, but over the portfolio manager's employment, making the chief investment officer a portfolio manager for the purposes of this book. A fund-of-funds manager retains control over the weights of the underlying fund managers and therefore is a portfolio manager. The typical mutual fund manager who issues orders for individual equity, fixed income, or derivative securities is the most visible form of portfolio manager.
A portfolio manager is held accountable for her performance whether or not it meets expectations. Portfolio managers typically have benchmarks, in the form of a market index or group of peers, and their performance results are compared with these benchmarks for client relationship, compensation, and career advancement purposes. Portfolio managers do not necessarily follow an active investment process. Managers of passive portfolios are portfolio managers because they are responsible and held accountable to their clients and firm for their portfolio returns. If performance does not meet client expectations, at some point the portfolio manager will be terminated.5 If results exceed expectations, clients may increase the level of their commitment, thereby generating higher management fees for the portfolio manager's firm. In these cases the portfolio manager will likely see career advancement.
Investment analysts may be held accountable for their recommendations, in some cases with precise performance calculations. However, they do not set security weights in portfolios and are not ultimately responsible for live performance. Portfolio managers may use analysts' recommendations in decision making, but the ultimate security selection is under their control. Although analysts are not portfolio managers based on the definition here, they can obviously benefit from understanding the job of the portfolio manager.
Risk officers are responsible for identifying, measuring, analyzing, and monitoring portfolio and firm risks. While they may have discretion to execute trades to bring portfolios into compliance, they are not portfolio managers. They do not bear the same responsibility and accountability for performance. In fact, it is recommended that portfolio management and risk functions be separated to avoid potential conflicts of interest.
1.3 WHAT INVESTMENT PROBLEMS DO PORTFOLIO MANAGERS SEEK TO SOLVE?
Asset Allocation and Asset Class Portfolio Responsibilities
The job of a portfolio manager is to help clients meet their wealth accumulation and spending needs. Many clients expect to preserve the real value of the original principal and spend only the real return. Some have well-defined cash inflows and outflows. Virtually all clients want their portfolio managers to maximize the value of their savings and protect from falling short of their needs.
The asset allocation problem requires portfolio managers to select the weights of asset classes, such as equities, bonds, and cash, through time to meet their clients' monetary needs. Asset allocation determines a large portion of the level and pattern of investment performance. The remainder is determined by the individual asset class vehicle(s) and their underlying holdings. The goals of asset allocation are to manage variability, provide for cash flow needs, and generate asset growth—in other words, risk and return, either absolute or relative to a target or benchmark. Clients are diversified in most situations by holding investments in several reasonably uncorrelated assets. Derivative instruments may help with this process. Asset allocation may also be a source of excess performance, with the portfolio manager actively adjusting weights to take advantage of perceived under- and overvaluations in the market.
Many portfolio managers do not make asset allocation decisions. Instead, they are hired to run a pool of money in a single asset class, or style within an asset class. They may have a narrowly defined benchmark and limited latitude to select securities outside of a prespecified universe—such as a small-cap value manager or distressed-high-yield-bond manager. In most cases, the strategy or style is independent of clients—the portfolio manager follows his or her investment process regardless of clients' broader wealth and spending needs. In fewer cases, portfolios are customized to clients' needs. For example, immunized fixed income portfolios involve customized duration matching and equity completeness funds are customized to provide dynamic, specialized sector and style characteristics.
Representative Investment Problems
Client relationships are typically defined by formal documents with stated investment objectives that include return goals, income needs, and risk parameters. Objectives and related guidelines are determined by the client type and individual situation and preferences.
More and more individual investors are seeking the support of professional portfolio managers. Retail mutual funds began growing rapidly in the bull market of the 1980s. There are now more mutual funds than stocks on the New York Stock Exchange, and hundreds of Exchange-Traded Funds (ETFs), all directed by portfolio managers. In many cases these managers are charged with individual asset class management, although the number of hybrid funds, requiring management of asset class weights, has grown rapidly since 2009. Currently popular horizon-based funds, which ended 2017 with $1.1 trillion in assets, are made up of multiple asset classes whose weights change through time in a prespecified fashion. Such funds require two levels of allocation—one determining the asset class weights and the other the fund or security weights within the individual asset classes.
The high-net-worth business has grown rapidly, with the level of service tied to client asset levels. Clients with more than $5 million in assets typically receive face-to-face advice on asset allocation and manager selection that is supplemented by other money-related services. Smaller clients receive a lower level of service through online questionnaires and phone conversations.
A defined benefit (DB) pension plan represents a pool of money set aside by a company, government institution, or union to pay workers a stipend in retirement determined by prespecified wage-based formulas. A DB plan is characterized by a schedule of forecast future cash flows whose shape is determined by the sponsor's employee demographics. The present value of this stream of payments, or liability, varies with interest rates. A portfolio manager's goal is to set both asset allocation and funding policies to meet these cash flow needs at the lowest possible cost and lowest risk of falling short of the required outflows. Plans frequently hire pension consultants6 to help them with in-house asset allocation, or in some cases hire external DB asset allocation managers. Accounting standards require U.S. corporations to include on their financial statements the effect of changes in liability present values relative to changes in the market values of the assets held to offset them. This requires close management of the relationship between assets and liabilities, and many companies are replacing their DB plans with alternative forms of employee retirement programs to avoid the inherent risk.
The most popular replacement vehicle is the defined contribution (401(k) or DC) plan. The DC plan is a hybrid program, combining company sponsors with individual users of the program. Individual employees decide how much to save and how to invest it and companies support the effort with contribution matching and advisory support services. Portfolio managers are hired by companies to provide diversified multi-asset investment options, individual asset class product management, and customized asset allocation advice and vehicle selection.
Portfolio managers are responsible for underlying asset class portfolios on a stand-alone basis and within multi-asset class products. Seldom are they the same as the asset allocators, since security-level portfolio management tends to involve a greater degree of specialization within the asset class; for example, high-yield bonds trade differently than investment-grade bonds, both of which trade differently than emerging market bonds. In most cases there are active and passive managers operating in the same asset class, though less liquid markets generally have fewer index funds. Asset classes with higher potential risk-adjusted active return (alpha) and less liquidity command higher fees and portfolio manager compensation for the same asset sizes. In these portfolios the managers are responsible for setting security weights, but they must also seek out available securities and be conscious of the ability to sell their positions.
1.4 SPECTRUM OF PORTFOLIO MANAGERS
Financial advisors provide individual and institutional clients with asset allocation recommendations, manager search capabilities, manager monitoring, and performance and risk analysis. Registered investment advisors (RIA) cater to high-net-worth investors and may also provide tax guidance, insurance strategy, estate planning, and expense management services. In some cases, sophisticated RIAs may be defined as money therapists, helping clients process their feelings about wealth, charitable giving, and handling money within their family. High-end advisors typically charge basis point fees that decline with increasing asset levels. Family offices may provide services beyond strict money management, even providing travel agent functions.
Pension consultants recommend investments and managers for institutional investors. They tend to be more rigorous in their process than managers of high-net-worth assets—for example, studying liability dynamics when proposing asset allocation and funding policies for a DB plan. Although RIAs may have earned their Certified Financial Planner® designation, which includes topics in estate planning and tax policy, many pension consultants will have earned their Chartered Financial Analyst® charter, a more rigorous professional certification. Many pension consulting firms have one or more liability actuaries on staff as well. Pension consultants talk in terms of benchmarks and portfolio risk, whereas advisors to smaller individual investors may focus on total assets. Although they are sophisticated, there is still a need to manage relations with pension clients. They may need to be educated about asset liability management, introduced to new asset classes, or supported in periods of unhealthy funding status. Pension plans, foundations, and endowments are known to blame (that is replace) their investment consultants when overall results are subpar.
Fund-of-funds managers take investment advice a step further, taking full discretion of assets, placing them with individual securities managers, and in many cases charging a performance fee for doing so. Funds-of-funds became popular in the new millennium by providing simultaneous exposure to a diversified mix of hedge funds.
Over the last two decades, traditional brokerage firms, or wire houses, have transitioned from commission-based to fee-based businesses, providing basic asset allocation services and in-house mutual fund products. They walk a fine line, balancing their clients' investment objectives with their own needs to sell their employer's products. Wrap accounts, popularized in the mid-1990s, are offered by brokerage houses and are composed of individual securities or mutual fund holdings. They offer separate accounting and flat basis point fee structures, including trading commissions. Trust banks, or trust departments of banks, are a smaller part of the business today but continue to manage pools of assets passed down between generations within trust vehicles. As banks have grown through consolidation, their trust management has become more centralized and standardized.
The mutual fund industry grew rapidly during the post-1981 equity and later bond bull markets. Individual investors returned to equity funds in droves during that period after withdrawing assets during the 1970s bear market. In the 1990s mutual fund firms sought to capture the growing DC market, as companies began favoring 401(k) plans over traditional DB programs. Mutual fund companies competed with investment performance,7 low-cost packages offering recordkeeping
