1、 2002 Level III Guideline Answers Morning Session - Page 1 LEVEL III, QUESTION 1 Topic: Portfolio Management Minutes: 26 Reading References: 1. “Determination of Portfolio Policies: Institutional Investors,” Ch. 4, Keith P. Ambachtsheer, John L. Maginn, and Jay Vawter, Managing Investment Portfolios
2、: A Dynamic Process, 2nd edition, John L. Maginn and Donald L. Tuttle, eds. (Warren, Gorham hence this is sometimes termed the “do nothing” strategy. The investor sets a floor below which s/he does not wish portfolio value to fall. An amount equal to the value of that floor is invested in some non-f
3、luctuating asset (i.e., Treasury bills, money market funds). The payoff diagram for a buy-and-hold strategy is a straight line, so the value of the portfolio rises (falls) as equity values rise (fall), with a slope equal to the equity proportion in the initial mix. The value of the portfolio will ne
4、ver fall below the specified floor, and the portfolio has unlimited upside potential. Increasing equity prices favor a buy and hold strategy; the greater the equity proportion in the initial mix, the better (worse) the strategy will perform when equities outperform (underperform) bills. The strategy
5、 is particularly appropriate for an investor whose risk tolerance above the specified floor varies with wealth, but drops to zero at or below that floor. After the initial portfolio transaction, transaction costs are not an issue. The strategy is tax efficient for taxable investors. ii. Constant-mix
6、 strategy. The constant-mix strategy maintains an exposure to equities that is a constant percentage of total wealth. Periodic rebalancing to return to the desired mix requires the purchase (sale) of equities as they decline (rise) in value. This strategy, 2002 Level III Guideline Answers Morning Se
7、ssion - Page 8 which generates a concave payoff diagram, offers relatively little downside protection and performs relatively poorly in up markets. The strategy performs best in a relatively flat (but oscillating or volatile) market and capitalizes on market reversals. The constant-mix strategy perf
8、orms particularly well in a time period when equity values oscillate greatly, but end close to their beginning levels; greater volatility around the beginning values accentuates the positive performance. The constant-mix strategy is particularly appropriate for an investor whose risk tolerance varie
9、s proportionately with wealth; such an investor will hold equities at all levels of wealth. This strategy requires some rule to determine when rebalancing takes place; typical approaches avoid transaction costs until either the value of a portion of the, or of the entire, portfolio has changed by a
10、given percentage. At this point, transaction costs are incurred to rebalance. Taxes can be material for taxable investors. iii. Constant-proportion strategy. The constant-proportion strategy maintains an exposure to equities that is a constant multiple of a “cushion” specified by the investor. The i
11、nvestor sets a floor below which s/he does not wish assets to fall, and the value of that floor is invested in some non-fluctuating asset (i.e., Treasury bills, money market funds). Under normal market conditions the value of the portfolio will not fall below this specified floor. The investor then
12、selects a multiplier to be used. The initial commitment to equities equals the multiplier times the “cushion” (the difference between the value of the total assets to be invested and the value of the floor) e.g., $ in equities = multiplier (assets floor). As equity values rise (fall), the constant-p
13、roportion strategy requires the investor to purchase (sell) additional equities. Thus following this strategy (via the formula indicated above) keeps equities at a constant multiple of the cushion (assets floor) and generates a convex payoff diagram. The constant-proportion strategy tends to give go
14、od downside protection and performs best in directional, especially up, markets; the strategy does poorly in flat but oscillating markets and is especially hurt by sharp market reversals. The strategy is particularly appropriate for an investor who has zero tolerance for risk below the stated floor
15、but whose risk tolerance increases quickly as equity values move above the stated floor. This strategy requires some rule to determine when rebalancing takes place; typical approaches avoid transaction costs until either the value of a portion of the, or of the entire, portfolio has changed by a giv
16、en percentage. At this point transaction costs are incurred to rebalance. Taxes can be material for taxable investors. 2002 Level III Guideline Answers Morning Session - Page 9 B. The constant-proportion strategy is the most appropriate rebalancing strategy for the JU endowment fund, taking into acc
17、ount the major circumstances described: the endowments increased risk tolerance, the outlook for a bull market in growth assets over the next five years, the expectation of lower than normal volatility, and the endowments desire to limit downside risk. The constant-proportion strategy is consistent
18、with higher risk tolerance, because the strategy calls for purchasing more equities as equities increase in value; higher risk tolerance is reflected in the resulting increased allocation to equities over time. The constant-proportion strategy will do well in an advancing equities market; by buying
19、equities as their values rise, each marginal purchase has a high payoff. The constant-proportion strategy would do poorly in a higher volatility environment for equities, because the strategy would sell on weakness but buy on strength, only to experience reversals; conversely, the strategy does much
20、 better in the face of lower volatility. The constant-proportion strategy provides good downside protection, because the strategy sells on weakness and reduces exposure to equities as a given floor is approached. In summary, given that JU receives little other funding support, the endowment fund mus
21、t produce the maximum return for a specified level of risk. Given that the level of acceptable risk is generally higher, although with a very specific downside floor, the market outlook suggests that the constant-proportion strategy is the endowment funds best rebalancing strategy. 2002 Level III Gu
22、ideline Answers Morning Session - Page 10 LEVEL III, QUESTION 3 Topic: Portfolio Management Minutes: 22 Reading Reference: 1. “Evaluation of Portfolio Performance,” Ch. 24 (omit pp. 658-664), Modern Portfolio Theory and Investment Analysis, 5thedition, Edwin Elton and Martin Gruber (John Wiley the T
23、reynor measure indicates that Joyner has a higher return per unit of systematic risk than Williamson, while the Sharpe ratio indicates that Joyner has a lower return per unit of total risk than Williamson. ii. Overall performance versus net selectivity. Overall performance is the portfolios return n
24、et of the risk-free rate and is therefore a return measure that does not consider risk. Because Joyners average annual rate of return is higher than Williamsons, its overall performance is also higher. Net selectivity, however, is a return measure that has been 2002 Level III Guideline Answers Morni
25、ng Session - Page 12 adjusted both for systematic risk and for unsystematic risk. To compute net selectivity, diversification is subtracted from selectivity. Because the diversification term is much higher for Joyner than for Williamson (the difference is 8.99% = 9.23% 0.24%), to achieve the same ne
26、t selectivity as Williamson, Joyner would need commensurately higher selectivity, which Joyner did not achieve (the difference is 7.66% = 8.08% 0.42%). The diversification measure indicates how much return would be required for the amount of non-systematic risk a manager is taking if non-systematic
27、risk received the same return as systematic risk. 2002 Level III Guideline Answers Morning Session - Page 13 LEVEL III, QUESTION 4 Topic: Portfolio Management Minutes: 16 Reading References: 1. “How Should Plan Sponsors Approach AIMR Performance Presentation Standards (PPS)? Learning from the Kentuc
28、ky Retirement System Example,” Chris Tobe, The Journal of Performance Measurement (The Spaulding Group, Winter 1998/1999), 2002 CFA Level III Candidate Readings 2. Question 5, including Guideline Answer, 1998 CFA Level III Examination (AIMR), 2002 CFA Level III Candidate Readings 3. “Global Investme
29、nt Performance Standards,” including Appendix A (AIMR, 1999), 2002 CFA Level III Candidate Readings Purpose: To test the candidates: a) understanding of the Global Investment Performance Standards, and b) ability to determine whether performance reports are in compliance with these standards. LOS: T
30、he candidate should be able to “How Should Plan Sponsors Approach AIMR Performance Presentation Standards (PPS)? Learning from the Kentucky Retirement System Example” (Study Session 17) a) identify the violations of the AIMR-PPS standards b) recommend changes to the performance presentations that wo
31、uld bring the presentations into compliance with the AIMR-PPS standards Question 5, including Guideline Answer, 1998 (Study Session 17) criticize a performance presentation that is not in compliance with the AIMR-PPS standards “Global Investment Performance Standards” (Study Session 17) c) explain t
32、he requirements and recommendations of GIPS standards with respect to input data, calculation methodology, composite construction, disclosures, and presentation and reporting d) explain the minimum procedures that must be followed to verify that an investment entity is GIPS compliant Guideline Answe
33、r: A. Items included in the Bristol Capital Management performance presentation report that are not compliant with GIPS: GIPS states that performance periods of less than one year must not be annualized, as Bristol does for the first quarter of 2002. GIPS verification cannot be performed for a singl
34、e composite as is stated in the notes to the Bristol report. Third party verification is performed with respect to the entire firm. For periods beginning January 1, 2001, portfolios must be valued at least monthly. Bristol is still valuing portfolios quarterly. 2002 Level III Guideline Answers Morni
35、ng Session - Page 14 A firm must use the compliance statement as specified in the GIPS. There are no provisions for partial compliance. If a firm does not meet all the GIPS requirements, then the firm is not in compliance with GIPS. Bristols use of the “except for” compliance statement is a violatio
36、n of GIPS. The column titled “Composite Dispersion (%)” is incomplete; it should be accompanied by a footnote describing the measure of dispersion being used. The column titled “Benchmark Return (%)” is incomplete; it should be accompanied by a footnote describing the composition of the benchmark. G
37、IPS states that accrual accounting must be used for fixed-income securities and all other assets that accrue interest income; Bristol states that it uses cash basis accounting for the recognition of interest income. B. Omissions that prevent the Bristol Capital Management performance report from bei
38、ng GIPS compliant: The availability of a complete list and description of all of Bristols composites is not disclosed as is required. Although Bristol does disclose the use of derivatives, the firm has omitted the required description of the extent of use, frequency, and characteristics of the instr
39、uments that must also be disclosed in sufficient detail to identify the risks. If the firm has included non-fee paying accounts in its composite, the percentage of the composite represented by these accounts must be disclosed. The composite creation date must be disclosed. Because the composite repr
40、esents a global investment strategy, the presentation should include information about the treatment of withholding tax on dividends, interest income, and capital gains. Because the composite is a global strategy, managed against a specific benchmark, the presentation should include information abou
41、t the percentage of the composite invested in countries/regions not included in the benchmark. Because the composite is a global strategy, managed against a specific benchmark, exchange rates presumably are a major performance factor; any known inconsistencies between the chosen source of exchange r
42、ates and the exchange rates of the benchmark must be described and presented. 2002 Level III Guideline Answers Morning Session - Page 15 LEVEL III, QUESTION 5 Topic: Portfolio Management Minutes: 36 Reading References: 1. “The Importance of the Investment Policy Statement” (AIMR, 1999), 2002 CFA Lev
43、el III Candidate Readings 2. “Individual Investors,” Ch. 3, Ronald W. Kaiser, Managing Investment Portfolios: A Dynamic Process, 2nd edition, John L. Maginn and Donald L. Tuttle, eds. (Warren, Gorham and beyond 20 years, post-retirement), three-stage (the next 15 pre-retirement years defined by work
44、/housing and college costs; the subsequent 5 pre-retirement years defined by work; and beyond 20 years post-retirement), or three-stage (the next five pre-retirement years defined by work/housing costs; the subsequent 15 pre-retirement years defined by work/college costs; and beyond 20 years post-re
45、tirement). Weakness of old constraint statement. The current IPS does not recognize the multi-stage time horizon issues. Liquidity New constraint statement. There is only a minor liquidity need ($18,000 in present value terms) to provide for education expenses for her daughter next year. After that
46、there is no liquidity need for the next five years. Only then ($375,000 in present value terms, for home construction) and in years 11 through 14 ($91,000 in present value terms, for sons education) are there significant liquidity concerns. The portfolio need not consider possible liquidity concerns
47、 with respect to the million-dollar gift for each child, because this is not a realistic goal. 2002 Level III Guideline Answers Morning Session - Page 18 Weakness of old constraint statement. The current policy overstates the liquidity needed to fund the educational expenses. These expenses are eith
48、er minor relative to the size of the portfolio or not a current liquidity concern. Taxes New constraint statement. Taxes are a critical concern, for two reasons. First, taxes are an important consideration in her retirement planning, because post retirement expenditures are after tax. Second, taxes
49、are an important consideration in her investment strategies because taxes are a potential drag on performance. Potential strategies to mitigate this second issue include employing a low turnover approach to equity investment and utilizing municipal bonds (income exempt from income taxes). Weakness of old constraint statement. The current policy only superficially addresses her tax status by suggesting that she hold only assets that generate little or no taxable income, as opposed to considering tax minimization strategies or ass
