Active / Passive Management

Question 1

Passive market strategies

Answer 1

• not attempting to outperform market
• should not require active intervention
• 2 techniques:
  - buy and hold
  - tracker

Question 2

3 types of tracker strategy

Answer 2

• full representation (buy shares in a all FTSE 100 companies in same split as the index) I.e. arithmatically weighted
• this can be very expensive if the index has a lot of very small cap shares in it eg FTSE all share
• stratified sampling - in a few companies for each sector in index
• this brings in element of active management
• biases often come in l, usually towards companies with an above average earnings
• manager may not be able to stratify to a sufficient level of detail to represent market accurately
• optimisation
• uses computer modelling
• synthetic
• getting exposure to index via derivatives rather than direct stocks

Question 3

Active management style - top down

Answer 3

1) top down - asset, geographic location, sector, stock
* uses fundamental analysis - company accounts, chairman’s statements etc
* Chartists - chart trends in stock prices regardless of company accounts

• assets allocation, uses:
  1) strategic asset allocation for the long term
  2) tactical asset allocation for the short term (quick wins)

Question 4

Active management - bottom up

Answer 4

• stocks picked on own merit
• stock picking e.g. value investing or GAARP (growth at a reasonable price) where stock is not cheap but good quality e.g. Amazon

Question 5

Advantages of using trackers (5)

Answer 5

• low cost
• less admin
• improved diversification
• reduces risk (especially non systematic/specific risk)
• easy to monitor performance
• easy to understand
• ability to plan taxable events
• Changes within the tracker attract no CGT
• often outperform active funds
• no limit to up side
• partial encashment possible
• covered by FSCS

Question 6

Disadvantages of selling shares to buy trackers / using trackers (5)

Answer 6

• less control
• potential CGT on sale of shares
• selling costs on existing portfolio
• no outperformance
• ongoing charges vs single shares
• index can be dominated by small number of stocks
• tracking error
• can not tailor portfolio to specific requirements

Question 7

How is FTSE 100 composed? (5)

Answer 7

• largest 100 companies
• weighted by market capitalisation
• listed in the UK in £
• that meet rules
• revises every 3 months

Question 8

Why is FTSE 100 not a good benchmark (when investing in a small number of shares) (3)

Answer 8

• FTSE100 does not reflect dividends
• index takes no account of tax or charges
• different composition / FTSE has more shares in it

Question 9

List and explain 4 stages of top down portfolio management (8)

Answer 9

• asset allocation
• manager decides split - eg 60% equity, 20 property, 10 bonds and 10 cash
• would be based on clients ATR
• allocate geographic distribution
• might mean investing in different parts of the world e.g. North America, UK, Europe and Far East
• chose sector weighting
• manager/adviser would look at particular sectors of the economy eg pharmaceutical or utilities
• stock or fund selection
• manager actually then chooses which particular stocks to invest in eg M & S
• alternatively could chose to invest in a fund which already has an appropriate stock selection

Question 10

What is technical analysis? (3)

Answer 10

• involves looking at past share prices
• and making investment decisions based on trends in those prices
• analysts use charts to determine their investments

Question 11

What is fundamental analysis (3)

Answer 11

• analysis of the company
• and sector the company operates in
• objective is to decide if they are undervalued or over valued
• analysis differs depending on if they are looking for value, growth or income shares

Question 12

How is FTSE 100 value calculated? (3)

Answer 12

• top 109 companies
• weighted by market cap
• with reference to a starting point of 1000

Question 13

How does a passive strategy which weights companies in FTSE 100 based on price to book value, free cashflow and dividend yield work? (4)

Answer 13

• stocks are selected on fundamentals
• not based on market cap
• may lead to outperformance
• can tailor strategy to client

Question 14

How are:

• price to book
• free cash flow
• dividend yield

calculated for a company

(6)

Answer 14

• Price to book. = market cap/ net assets (or share price/ net assets per share)
• free cashflow = operating cashflow / net assets
• div yield = div per share / share price

Question 15

What is the purpose of using a benchmark in the investment process (4)

Answer 15

• sets the asset allocation/. Starting point
• to manage risk and return
• to measure relative performance
• Independant measure
• measure value added by manager

Question 16

Why recommend ETFs over hedge fund (5)

Answer 16

• better liquidity
• easier to benchmark performance
• low min investment
• low charges
• passive funds don’t rely on a managers strategy
• consumer protector / regulated by FCA