Managing Investment Portfolios: A Dynamic Process (Cfa Institute Investment)

In this latest edition, financial experts John Maginn, Donald Tuttle, Jerald Pinto, and Dennis McLeavey—along with a number of experienced contributors—fully update information associated with this important discipline by examining everything from asset allocation strategies to risk management frameworks. Blending theory with practice, they skillfully outline the entire flow of the portfolio management process—from formulating an investment policy statement to portfolio construction, trade execution, and monitoring and rebalancing a portfolio. Throughout the text, special attention is paid to ensuring the evenness of subject matter, consistencyof mathematical notation, and continuity of topic coverage that is so critical to the learning process.

Other elements that are discussed in detail include:

• Managing individual and institutional investor portfolios

• Capital market expectations

• Fixed income and equity portfolio management

• Evaluating portfolio performance

• Alternative investment portfolio management

• Global investment performance standards

And to further enhance your understanding of the tools and techniques explored here, don't forget to pick up Managing Investment Portfolios Workbook, Third Edition—a comprehensive companion study guide containing Learning Outcomes and Summary Overview sections along with challenging practice questions and solutions.

With each contributor bringing his own unique experiences and perspectives to the portfoliomanagement process, Managing Investment Portfolios, Third Edition distills the knowledge, skills, and abilities you need to succeed in today's fast-paced financial world.

--Martin L. Leibowitz, Morgan Stanley

Managing Investment Portfolios remains the definitive volume in explaining investment management as a process, providing organization and structure to a complex, multipart set of concepts and procedures. Anyone involved in the management of portfolios will benefit from a careful reading of this new edition.

--Charles P. Jones, CFA, Edwin Gill Professor of Finance, College of Management, North Carolina State University

DONALD L. TUTTLE, CFA, was vice president of CFA Institute in its Curriculum and Examinations Department from 1992 until his retirement in 2004. He received a BSBA and MBA from the University of Florida and a PhD from the University of North Carolina at Chapel Hill. Dr. Tuttle taught for 21 years at Indiana University, where he chaired the Finance Department from 1970 to 1980. He was Associate Professor of Finance at the University of North Carolina and was a visiting professor at the European Institute of Business Administration (INSEAD), the University Florida, Georgetown University, and the University of Virginia. He has authored numerous articles in leading finance journals and five books on security analysis and portfolio management. He is a member of the Advisory Board of The Journal of Portfolio Management and was a trustee of over 100 mutual funds from 1982 to mandatory retirement age in 2005.

JERALD E. PINTO, PHD, CFA, is Director in of Curriculum Development   at CFA Institute. Before coming to CFA Institute in 2002, he was a consultant to corporations, foundations, and partnerships in investment planning, portfolio analysis, and quantitative analysis. He has also worked in the investment and banking industries in New York City and taught finance at New York University's Stern School of Business. He holds an MBA from Baruch College and a PhD in finance from the Stern School. Pinto obtained his CFA charter in 1992.

DENNIS W. McLEAVEY, CFA, is Head of Professional Development Products at CFA Institute. During his twenty-five-year academic career, he taught at the University of Western Ontario, the University of Connecticut, the University of Rhode Island (where he founded a student-managed fund), and Babson College. McLeavey completed a doctorate in production management and industrial engineering at Indiana University in 1972, and earned his CFA charter in 1990.

Preface.

Acknowledgments.

Introduction.

CHAPTER 1: The Portfolio Management Process and the Investment Policy Statement.

1 Introduction.

2 Investment Management.

3 The Portfolio Perspective.

4 Portfolio Management as a Process.

5 The Portfolio Management Process Logic.

5.1 The Planning Step.

5.2 The Execution Step.

5.3 The Feedback Step.

5.4 A Definition of Portfolio Management.

6 Investment Objectives and Constraints.

6.1 Objectives.

6.2 Constraints.

7 The Dynamics of the Process.

8 The Future of Portfolio Management.

9 The Ethical Responsibilities of Portfolio Managers.

CHAPTER 2: Managing Individual Investor Portfolios.

1 Introduction.

2 CaseStudy.

2.1 The Inger Family.

2.2 Inger Family Data.

2.3 Jourdan’s Findings and Personal Observations.

3 Investor Characteristics.

3.1 Situational Profiling.

3.2 Psychological Profiling.

4 Investment Policy Statement.

4.1 Setting Return and Risk Objectives.

4.2 Constraints.

5 An Introduction to Asset Allocation.

5.1 Asset Allocation Concepts.

5.2 Monte Carlo Simulation in Personal Retirement Planning.

CHAPTER 3: Managing Institutional Investor Portfolios.

1 Overview.

2 PensionFunds.

2.1 Defined-Benefit Plans: Background and Investment Setting.

2.2 Defined-Contribution Plans: Background and Investment Setting.

2.3 Hybrid and Other Plans.

3 Foundations and Endowments.

3.1 Foundations: Background and Investment Setting.

3.2 Endowments: Background and Investment Setting.

4 The Insurance Industry.

4.1 Life Insurance Companies: Background and Investment Setting.

4.2 Non–Life Insurance Companies: Background and Investment Setting.

5 Banks and Other Institutional Investors.

5.1 Banks: Background and Investment Setting.

5.2 Other Institutional Investors: Investment Intermediaries.

CHAPTER 4: Capital Market Expectations.

1 Introduction.

2 Organizing the Task: Framework and Challenges.

2.1 A Framework for Developing Capital Market Expectations.

2.2 Challenges in Forecasting.

3 Tools for Formulating Capital Market Expectations.

3.1 Formal Tools.

3.2 Survey and Panel Methods.

3.3 Judgment.

4 Economic Analysis.

4.1 Business Cycle Analysis.

4.2 Economic Growth Trends.

4.3 Exogenous Shocks.

4.4 International Interactions.

4.5 Economic Forecasting.

4.6 Using Economic Information in Forecasting Asset Class Returns.

4.7 Information Sources for Economic Data and Forecasts.

CHAPTER 5: Asset Allocation.

1 Introduction.

2 What is Asset Allocation?

2.1 The Role of Strategic Asset Allocation in Relation to Systematic Risk.

2.2 Strategic versus Tactical Asset Allocation.

2.3 The Empirical Debate on the Importance of Asset Allocation.

3 Asset Allocation and the Investor’s Risk and Return Objectives.

3.1 Asset-Only and Asset/LiabilityManagement Approaches to Strategic Asset Allocation.

3.2 Return Objectives and Strategic Asset Allocation.

3.3 Risk Objectives and Strategic Asset Allocation.

3.4 Behavioral Influences on Asset Allocation.

4 The Selection of Asset Classes.

4.1 Criteria for Specifying Asset Classes.

4.2 The Inclusion of International Assets (Developed and Emerging Markets).

4.3 Alternative Investments.

5 The Steps in Asset Allocation.

6 Optimization.

6.1 The Mean–Variance Approach.

6.2 The Resampled Efficient Frontier.

6.3 The Black–Litterman Approach.

6.4 Monte Carlo Simulation.

6.5 Asset/Liability Management.

6.6 Experience-Based Approaches.

7 Implementing the Strategic Asset Allocation.

7.1 Implementation Choices.

7.2 Currency Risk Management Decisions.

7.3 Rebalancing to the Strategic Asset Allocation.

8 Strategic Asset Allocation for Individual Investors.

8.1 Human Capital.

8.2 Other Considerations in Asset Allocation for Individual Investors.

9 Strategic Asset Allocation for Institutional Investors.

9.1 Defined-Benefit Plans.

9.2 Foundations and Endowments.

9.3 Insurance Companies.

9.4 Banks.

10 Tactical Asset Allocation.

CHAPTER 6: Fixed-Income Portfolio Management.

1 Introduction.

2 A Framework for Fixed-Income Portfolio Management.

3 Managing Funds Against a Bond Market Index.

3.1 Classification of Strategies.

3.2 Indexing (Pure and Enhanced).

3.3 Active Strategies.

3.4 Monitoring/Adjusting the Portfolio and Performance Evaluation.

4 Managing Funds Against Liabilities.

4.1 Dedication Strategies.

4.2 Cash-Flow Matching Strategies.

5 Other Fixed-Income Strategies.

5.1 Combination Strategies.

5.2 Leverage.

5.3 Derivatives-Enabled Strategies.

6 International Bond Investing.

6.1 Active versus Passive Management.

6.2 Currency Risk.

6.3 Breakeven Spread Analysis.

6.4 Emerging Market Debt.

7 Selecting a Fixed-Income Manager.

7.1 Historical Performance as a Predictor of Future Performance.

7.2 Developing Criteria for the Selection.

7.3 Comparison with Selection of Equity Managers.

CHAPTER 7: Equity Portfolio Management.

1 Introduction.

2 The Role of the Equity Portfolio.

3 Approaches to Equity Investment.

4 Passive Equity Investing.

4.1 Equity Indices.

4.2 Passive Investment Vehicles.

5 Active Equity Investing.

5.1 Equity Styles.

5.2 Socially Responsible Investing.

5.3 Long–Short Investing.

5.4 Sell Disciplines/Trading.

6 Semiactive Equity Investing.

7 Managing a Portfolio of Managers.

7.1 Core Satellite.

7.2 Completeness Fund.

7.3 Other Approaches: Alpha and Beta Separation.

8 Identifying, Selecting, and Contracting with Equity Portfolio Managers.

8.1 Developing a Universe of Suitable Manager Candidates.

8.2 The Predictive Power of Past Performance.

8.3 Fee Structures.

8.4 The Equity Manager Questionnaire.

9 Structuring Equity Research and Security Selection.

9.1 Top-Down versus Bottom-Up Approaches.

9.2 Buy-Side versus Sell-Side Research.

9.3 Industry Classification.

CHAPTER 8: Alternative Investments Portfolio Management.

1 Introduction.

2 Alternative Investments: Definitions, Similarities, and Contrasts.

3 Real Estate.

3.1 The Real Estate Market.

3.2 Benchmarks and Historical Performance.

3.3 Real Estate: Investment Characteristics and Roles.

4 Private Equity/Venture Capital.

4.1 The Private Equity Market.

4.2 Benchmarks and Historical Performance.

4.3 Private Equity: Investment Characteristics and Roles.

5 Commodity Investments.

5.1 The Commodity Market.

5.2 Benchmarks and Historical Performance.

5.3 Commodities: Investment Characteristics and Roles.

6 Hedge Funds.

6.1 The Hedge Fund Market.

6.2 Benchmarks and Historical Performance.

6.3 Hedge Funds: Investment Characteristics and Roles.

6.4 Performance Evaluation Concerns.

7 Managed Futures.

7.1 The Managed Futures Market.

7.2 Benchmarks and Historical Performance.

7.3 Managed Futures: Investment Characteristics and Roles.

8 Distressed Securities.

8.1 The Distressed Securities Market.

8.2 Benchmarks and Historical Performance.

8.3 Distressed Securities: Investment Characteristics and Roles.

CHAPTER 9: Risk Management.

1 Introduction.

2 Risk Management as a Process.

3 Risk Governance.

4 Identifying Risks.

4.1 Market Risk.

4.2 Credit Risk.

4.3 Liquidity Risk.

4.4 Operational Risk.

4.5 Model Risk.

4.6 Settlement (Herstatt) Risk.

4.7 Regulatory Risk.

4.8 Legal/Contract Risk.

4.9 Tax Risk.

4.10 Accounting Risk.

4.11 Sovereign and Political Risks.

4.12 Other Risks.

5 Measuring Risk.

5.1 Measuring Market Risk.

5.2 Value at Risk.

5.3 The Advantages and Limitations of VaR.

5.4 Extensions and Supplements to VaR.

5.5 Stress Testing.

5.6 Measuring Credit Risk.

5.7 Liquidity Risk.

5.8 Measuring Nonfinancial Risks.

6 Managing Risk.

6.1 Managing Market Risk.

6.2 Managing Credit Risk.

6.3 Performance Evaluation.

6.4 Capital Allocation.

6.5 Psychological and Behavioral Considerations.

CHAPTER 10: Execution of Portfolio Decisions.

1 Introduction.

2 The Context of Trading: Market Microstructure.

2.1 Order Types.

2.2 Types of Markets.

2.3 The Roles of Brokers and Dealers.

2.4 Evaluating Market Quality.

3 The Costs of Trading.

3.1 Transaction Cost Components.

3.2 Pretrade Analysis: Econometric Models for Costs.

4 Types of Traders and Their Preferred Order Types.

4.1 The Types of Traders.

4.2 Traders’ Selection of Order Types.

5 Trade Execution Decisions and Tactics.

5.1 Decisions Related to the Handling of a Trade.

5.2 Objectives in Trading and Trading Tactics.

5.3 Automated Trading.

6 Serving the Client’s Interests.

6.1 CFA Institute Trade Management Guidelines.

6.2 The Importance of an Ethical Focus.

7 Concluding Remarks.

CHAPTER 11: Monitoring And Rebalancing.

1 Introduction.

2 Monitoring.

2.1 Monitoring Changes in Investor Circumstances and Constraints.

2.2 Monitoring Market and Economic Changes.

2.3 Monitoring the Portfolio.

3 Rebalancing the Portfolio.

3.1 The Benefits and Costs of Rebalancing.

3.2 Rebalancing Disciplines.

3.3 The Perold–Sharpe Analysis of Rebalancing Strategies.

3.4 Execution Choices in Rebalancing.

4 Concluding Remarks.

CHAPTER 12: Evaluating Portfolio Performance.

1 Introduction.

2 The Importance of Performance Evaluation.

2.1 The Fund Sponsor’s Perspective.

2.2 The Investment Manager’s Perspective.

3 The Three Components of Performance Evaluation.

4 Performance Measurement.

4.1 Performance Measurement without Intraperiod External Cash Flows.

4.2 Total Rate of Return.

4.3 The Time-Weighted Rate of Return.

4.4 The Money-Weighted Rate of Return.

4.5 TWR versus MWR.

4.6 The Linked Internal Rate of Return.

4.7 Annualized Return.

4.8 Data Quality Issues.

5 Benchmarks.

5.1 Concept of a Benchmark.

5.2 Properties of a Valid Benchmark.

5.3 Types of Benchmarks.

5.4 Building Custom Security-Based Benchmarks.

5.5 Critique of Manager Universes as Benchmarks.

5.6 Tests of Benchmark Quality.

5.7 Hedge Funds and Hedge Fund Benchmarks.

6 Performance Attribution.

6.1 Impact Equals Weight Times Return.

6.2 Macro Attribution Overview.

6.3 Macro Attribution Inputs.

6.4 Conducting a Macro Attribution Analysis.

6.5 Micro Attribution Overview.

6.6 Sector Weighting/Stock Selection Micro Attribution.

6.7 Fundamental Factor Model Micro Attribution.

6.8 Fixed-Income Attribution.

7 Performance Appraisal.

7.1 Risk-Adjusted Performance Appraisal Measures.

7.2 Quality Control Charts.

7.3 Interpreting the Quality Control Chart.

8 The Practice of Performance Evaluation.

8.1 Noisiness of Performance Data.

8.2 Manager Continuation Policy.

8.3 Manager Continuation Policy as a Filter.

CHAPTER 13: Global Investment Performance Standards.

1 Introduction.

2 Background of the GIPS Standards.

2.1 The Need for Global Investment Performance Standards.

2.2 The Development of Performance Presentation Standards.

2.3 Governance of the GIPS Standards.

2.4 Overview of the GIPS Standards.

3 Provisions of the GIPS Standards.

3.1 Fundamentals of Compliance.

3.2 Input Data.

3.3 Calculation Methodology: Time-Weighted Total Return.

3.4 Return Calculations: External Cash Flows.

3.5 Additional Portfolio Return Calculation Standards.

3.6 Composite Return Calculation Standards.

3.7 Constructing Composites I—Defining Discretion.

3.8 Constructing Composites II—Defining Investment Strategies.

3.9 Constructing Composites III—Including and Excluding Portfolios.

3.10 Constructing Composites IV—Carve-Out Segments.

3.11 Disclosure Standards.

3.12 Presentation and Reporting Requirements.

3.13 Presentation and Reporting Recommendations.

3.14 Introduction to the Real Estate and Private Equity Provisions.

3.15 Real Estate Standards.

3.16 Private Equity Standards.

4 Verification.

5 GIPS Advertising Guidelines.

6 Other Issues.

6.1 After-Tax Return Calculation Methodology.

6.2 Keeping Current with the GIPS Standards.

Appendix: GIPS Glossary.

Glossary.

References.

About the CFA Program.

About the Authors.

Index.