Chapter 21:Portfolio Management(1)

[Ayushi Arora]

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

 

[Ayushi Arora]

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

 

[David Wilmot]

Hi,
I have another doubt from section 3.2 Active Bond management

Hi Ayushi,

You have posted two different enquiries in the same thread. Please delete this second one and post it in a separate thread. This will increase the likelihood of you receiving a reply from other forum users. Thank you

David

 

[David Wilmot]

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 Ayushi,

It is unclear from your post what you are asking. You refer to "lines" (plural) so, which of the following are you asking for help with:

1. "index-trackers who manage assets without attempting to generate any outperformance from making superior investment decisions"?
2. "objective is to track closely the performance of a specified equity index"?
3. "lower cost and volatility"?
4. "loss of upside potential"?
5. "implicit restriction to countries, markets or sectors where a suitable benchmark exists"?

David

 

[Ayushi Arora]

Hi Ayushi,

It is unclear from your post what you are asking. You refer to "lines" (plural) so, which of the following are you asking for help with:

1. "index-trackers who manage assets without attempting to generate any outperformance from making superior investment decisions"?
2. "objective is to track closely the performance of a specified equity index"?
3. "lower cost and volatility"?
4. "loss of upside potential"?
5. "implicit restriction to countries, markets or sectors where a suitable benchmark exists"?

David

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"?

 

[Ayushi Arora]

Hi
Please help me understand this concept.

 

[Joe Hook]

Passive management is akin to index tracking. In order to be able to index track there must be an index. This is easy enough if i'm interested in the biggest 100 companies in the UK, I have the FTSE 100. I can even track certain industries eg UK aerospace companies if I want to be niche as a published index exists.

But I might struggle to find a suitable index if I want to invest in smaller countries eg Liechtenstein which does not have a stock exchange but does have investible shares. Similarly if I wanted to invest in a niche sector eg Chinese TV manufacturers.

These examples might seem a little absurd but hopefully it illustrates the point that if we want to passively manage we need an index. And if an index doesn't exist we're a little stuck!

Joe

 

[GottaStudyHard]

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 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