Securities Lending
1) Explain
2) Factors to consider
3) Rebate rate formula
1) Explain
Lending securities owned to a borrower who needs them for short-selling. Ownership of the underlying shares retained therefore retaining the upside, but, voting rights transferred to the borrower
2) Factors
- borrower holding your shares therefore divs get paid to them, they need to pay you the equivalent in cash
- counterparty credit risk of the borrower
- invest cash posted as collateral to increase yield
- invested cash subject to market risk
- administrative cost of securities lending program will decrease yield
3) Rebate Rate = collateral earnings rate - securities lending rate
Basis risk?
Basis risk arises from:
- using a hedging instrument that is imperfectly matched to the underlying
- i.e. when underlying pays dividends whilst the futures contract only tracks price of underlying index
Information Coefficient (IC)?
The IC =
correlation between a securities factor score and subsequent returns of the security
- high IC = factor has predictive power
Trading costs
1) List groups
2) List types of costs within those groups
Trading costs
1) Implicit and Explicit
2) Implicit
- bid-ask spreads
- market impact
- delay costs
Explicit
- broker commissions
- stock fees
- taxes
Returns-based and Holdings-based approached to style classification
Holdings-based
- have actual holdings, therefore deeper analysis possible
- use portfolio vs benchmark charachteristics given
Returns-based style analysis
- can’t always see what a manager is holding
- therefore analysed by comparing his returns to those of a set of style indexes
- need historical returns for the portfolio and the style indexes
- If given a few exhibits, look for the regression info and use that for returns-based holdings analysis!
Hedged portfolio approach (Factor-based investing subcategory)
1) List steps
2) List drawbacks
Hedged portfolio approach
1) Steps
- select factor
- rank stocks by that factor
- divide into quartiles, quintiles or deciles
- long best, short worst
2) drawbacks
- requires shorting
- info in middle quintile ignored
- portfolios tend to be concentrated and crowded
- not a pure factor portfolio
- assumes rel between factor & future returns = linear
Style Factors
1) List the rewarded style factors
Style factors
1) Value - aiming to caputure excess returns from stocks that have low prices relative to their fundamental value.
- low P/B, low P/E, high earnings yield
- value premium for increased risk of financial distress
2) Size - historically, portfolios with small-cap exhibit greater returns than portfolios with just large cap stocks
3) Momentum - winners over past 12 months tend to outperform past losers over next 2-12 months
- attributed to overreaction to info: gets crowded and left-tail risk
4) Growth - using historical or projected growth rates
5) Quality - low debt, stable earnings, consistent asset g, strong corp gov
- ROE, D/E, Earnings variability
6) Volatility - low vol stocks tend to earn greater risk adjusted returns
What is a Value Trap?
Value Trap
Stock may appear to be attractively valued (low P/E, P/B), but may be overpriced given it’s worsening future prospects
What is a Growth Trap?
Growth Trap
Future growth may not materialize, or everything is already priced in
Active Risk
1) Formula
2) What is it?
Active Risk
1) σRA = Sqrt(σ2(Bpk-Bbk) x Fk)+σ2e)
another way: σRA = Sqrt(σ2active return)
2) Measure of volatility of portfolio returns rel to volatility of benchmark returns
- high net exposure to a risk factor = high active risk
- if net = 0 - active risk fully attributed to active share
- AR rises with increase in factor & idiosyncratic vol
- affected by degree of cross correlatoin (active share not)
- manager can’t completely control actrive risk (vs active share)
Level of active risk attributed to active share = small if:
- # securities large (diversified)
- average idiosyncratic risk = small
Active Share
Active Share = % of Portfolio that differs from the benchmark
1) AS = 50% (Σ | wpi - wbi | )
measures extent to which number and sizing of positions differ from benchmark
- PM has complete control over Active Share
- 0% = index (no difference)
- 100% = completely independent
