Chapter 21:Portfolio Management(1)

Hi,
I am not clear with the following core reading under section 2.4 "Index Tracking" highlighted below:

Passive investment managers are, typically, index-trackers who manage assets without attempting to generate any outperformance from making superior investment decisions. Instead, their objective is to track closely the performance of a specified equity index. This offers the advantages of lower cost and volatility, but with the loss of upside potential and the implicit restriction to countries, markets or sectors where a suitable benchmark exists.

Please help me understand what these lines mean here.

Thanks

 

Hi,
I have another doubt from section 3.2 Active Bond management
Following are the core reading:

There is typically only a limited range of circumstances in which an individual bond will outperform its peers and provide a higher return than its yield-to-maturity at the point of purchase, which include:

• The issuer’s perceived creditworthiness being upgraded or ‘corrected’ relative to other issuers – for example, a credit ratings upgrade – resulting in an upward adjustment in the bond’s price (downgrades may be equally profitable for investors who hold short positions).

There is another core reading statement after few para just before switching topic:

Other areas where an active bond manager could generate outperformance include having a lower average credit rating than the benchmark or peer group (resulting in a higher yield which is hopefully not negated by higher defaults), or seeking yield enhancement by identifying the ‘cheapest’ bond from a group of similar issues having otherwise similar ratings, liquidity, size, and so on.

Aren't these core reading conflicting ?
At first it is said that outperformance is possible if there is upgrading (leading to bond price increase) and later core reading states outperformance is possible if there is downgrading (leading to bond price decrease). please help me in understanding how these two different core reading makes sense and are not conflicting.

Thanks in advance for helping me

 

Hi David,
I had highlighted the lines and mentioned the same while framing my question. Sorry for being not very clear.
Can you please help me understand point 5. "implicit restriction to countries, markets or sectors where a suitable benchmark exists"?

 

Hi
Please help me understand this concept.

 

Hi from what I understand, there is no conflict, the first excerpt states:
"There is typically only a limited range of circumstances in which an individual bond will outperform its peers and provide a higher return than its yield-to-maturity at the point of purchase"

The yield-to-maturity is calculated based on the assumption that the investor will hold the bond until maturity. If the bond gets a credit upgrade, the price will increase. Once the price has increased, it can be sold in the open market and the return earned will be higher than the yield-to-maturity calculated using assumptions before the credit upgrade. This "individual" bond would then outperform other similar bonds in the market.

The second excerpt states:
"Other areas where an active bond manager could generate outperformance include having a lower average credit rating than the benchmark or peer group"

No credit downgrade was mentioned here, it was simply stated that the bond manager needs to hold bonds with a lower credit rating relative to the benchmark/peer groups at the outset of creating the investment portfolio. This would increase the credit risk, however, it would also provide a higher expected return relative to the benchmark/peer group. If a sufficient number of these higher-risk bonds do not default, then "superior" returns would be generated.

Hope this helps