Index

Absolute marginal contributions to tracking error (ACTE), 380-383 Absolute marginal factor contributions to tracking error (AFCTE), 384 Absolute return strategy, 444 Accounting agents, valuations,

289-290 Active management:

characteristics of, generally, 22,

25-26, 105, 154, 181 country allocation strategy, 445-446 currency allocation strategy, 446 duration timing strategy, 444 goal of, 212

risk budgeting and, 446-451 sector allocation strategy, 445 security selection strategies, 445 yield curve positioning strategy, 444-445 Active portfolio, defined, 374-375 Active return, 174 Active risk: correlations of, 479-480 implications of, 26, 153, 168 investments, structured vs.

traditional, 198-199 management, structured vs.

traditional, 193-197 management selection, 199-209 in risk budget, 171-185 Active trading, 125 Actuarial decision analysis, 418 Actuarial mortality tables, 111 Administration costs, 411 After-tax wealth:

after-tax returns, calculation of,

541-544 appreciation, 539 capital gains, 536-539, 541-542

components of, 534 estate tax, 537-538, 544-545 gift tax, 537-538 income tax, 536 inflation, 540-541, 545, 564 planning framework, 535-536 spending, 540-541, 545, 562 subsidies, 539

taxation considerations, 536-540, 544

transfer tax, 537, 544-545 Agency bonds, 99 Aggressive investors/trades, 10,

431-432, 558, 560 Allocation, see Asset allocation Alpha, 154, 159, 174-179, 181, 185, 188, 275-277, 343, 387, 457, 498, 501, 510,524-525, 530 Alternative asset classes: characteristics of, 153 global tactical asset allocation

(GTAA), 455-482 hedge funds, portfolio management, 501-515

private equity investments, 516-530 strategic asset allocation, hedge funds, 483-500 Altvest, 486

American depositary receipts (ADRs),

319, 376 Analyst earnings estimate anomaly, 421

Annual growth rate, 50 Annual returns, 547, 554-558 Annuities, 568

Appreciation, 539, 548, 565, 579,

582 Arbitrage, 490 Arbitrage trading, 295

Asset allocation: characteristics of, 14-15, 22 drift, 412-414 global tactical, 455-482 paradigm, 106 in risk management, 24-25 strategic, see Strategic asset allocation wealth generation, 592 Asset classes:

alternative, 105, 453-530 Black-Litterman approach, 76-79 currency hedging, impact of,

140-151 implications of, 19, 21 in market portfolio, 100-103 risk characteristics, 108-109 risk management, 25 timing, 458, 474 Asset consumption, 49 Asset demands, 49 Asset exposures, equity risk factor models: country, 351-353 currency, 353 industry, 350-351 investment style/risk, 351 in linear factor model, 354-355 local market, 351-353 standardizing, 353-354 Asset grouping, return attribution: contributions to returns, 332-333 international portfolio, 322-327 Asset-level contributions, return attribution, 320-322, 327-328 Asset location strategies, 571-579 Asset management:

forecasting models, 76-78 importance of, 28 Asset pricing, 48 Asset universe, 356 Association for Investment

Management and Research (AIMR), 477 Asymptotic principal component

(APC), 345, 347 Auditing tools, 293 Average returns, 107

Backfill bias, 487 Bank accounts, 565 Barbelled portfolios, 192, 437 Becker, Gary, 102 Benchmark(s):

performance measurement, 278

portfolio, defined, 374-375 in portfolio construction, 427 in risk budgeting, 446-447 in risk management, 25-26, 28 Bequest mode, 542, 587 Bermuda, 352

Beta, 30, 42-43, 87-88, 101, 147, 149, 155, 174, 176, 200, 221-222, 276-277, 303, 343, 352-353, 386-388, 476 Beta-neutral, 476 Bid/ask spread, 289, 472 Black, Fischer, 56, 73, 76 Black-Litterman models: active risk, 184-185 global asset allocation model, see Black-Litterman global asset allocation model global tactical asset allocation, 467 Black-Litterman global asset allocation model: active risk, 184-185, 191 development of, 76-77 expected returns, 77-84, 431 German equity market, 79-80, 82-84

global minimum-variance portfolio, 87-88

Japanese equity market, 84 optimal portfolio weights, 76, 78, 81,

86-87 overview, 76-78 parameter changes, impact of,

85-87 risk constraints, 87-88 unconstrained mean-variance optimization, 81 unconstrained optimal portfolio, 77, 80-81, 83-85, 87 Black-Scholes option pricing model, 246, 439

Block diagonal global equity factor model, 367-369, 371-372 Bond/equity split, 104, 109-110, 124 Bond futures, 414, 470-471 Bond investments, see Bond portfolio Capital Asset Pricing Model

(CAPM), 40 portfolio risk, 36-38 Bond market:

after-tax wealth applications,

558-564 annual returns, 547, 554-558 historic returns, 546-550 inflation, impact on, 547, 549-553 investment horizon, 558 risk-adjusted returns, 553-554 Bond portfolio, generally:

436 liabilities, 114 Book-to-market equity, 422 Book-to-price (B/P) ratio, 423, 461, 463

Bottom-up asset allocation, 26 Broker-dealers, 287-288 Broker quotes, 289-290, 292, 294 Budgeting, in risk management, 252 Bulleted portfolios, 437 Bush, President George W., 550 Business plan, 256 Buy-and-hold strategies, 196, 542,

579-580, 587 Buy-side traders, 432

Callable bonds, 440 Capital appreciation, 436, 567 Capital Asset Pricing Model (CAPM): components of, 36-37 development of, 36 expected returns, 40 global equilibrium, 77 implementation of, 103 international, 56, 66 market portfolio, 91, 100-101, 103 optimal portfolio, 41-42 risk aversion, 38-39 risk premium, 42-43 testing, 103

time period, 37 uncorrelated assets, 152, 155 Capital depreciation, 436 Capital gains/capital gains tax, 30, 47, 534,536-539, 541-542, 565, 569, 579-580, 585 Capital markets, 460 Capital market theory, 179 Carried interest, 519 Carve-outs, 414 Cash, generally:

Capital Asset Pricing Model

(CAPM), 37, 40 completion management, 414-415 effects on tracking errors, 390-392 equity risk factor models, 375-376 global tactical asset allocation

(GTAA), 470, 472 international portfolios, 319 Cash flow, 27, 280, 435, 437 Cash flow projections, 112 Cautious investors, 10 Central banks, 460-461, 550 Charitable gifts, 566 Charitable remainder trust (CRT), 566,

568-569, 576, 578 Chen, Peng, 45, 47-48 Children, wealth creation strategies,

566, 570, 574 Clinical decision analysis, 418 Closing price, 295, 431 Collateral, 470

Collateralized mortgage obligations

(CMOs), 441 Combined single region model (SRM), global equity factor model, 367-369, 371-373 Commercial real estate, 101-102 Commingled vehicles, 410-412 Commissions, 472 Commodities, 20-22, 25, 103, 153 Commodity Futures Trading

Commission (CFTC), 474 Common stock, 99 Completion management, 414-415 Completion manager, 468 Completion portfolio, GTAA, 455, 457-458

Compounding, 564, 582 Compounding period, return attribution, 313 Computer software: portfolio optimization, 161, 297 return attribution, 313 Concentrated active management, 26 Confidence levels, 185-190 Conservative investors, 561 Consumer price index (CPI), 553 Consumption habits, 52 Contingency planning, 254 Contribution to duration (CTD), 437,

442, 444 Controllers, functions of, 290 Convertible arbitrage, 490, 494-495, 498

Convexity, volatility risk, 439, 445 Core portfolio, 582-586 Corporate bonds, 53, 437, 445, 565 Corporate credit, 99 Correlated assets, 153 Correlation(s): covariance matrix estimation,

230-232 in modern portfolio theory (MPT), 12-13, 20-22 Cost basis, 586

Country allocation strategy, 323-324,

445-446 Country asset exposures, 351-353 Country contributions, return attribution: international portfolios, 323-325 single region, 306 Country currency weight, 323-324 Country effect: global equity risk factor models,

365-367 global factor model, return attribution, 320-322 Country indexes, 92 Country of domicile, 351, 355 Country of issuance, 351-352 Country sector weight, 324-325 Country selection, global tactical asset allocation (GTAA), 458, 459, 474 Country stock selection, 324

62-64, 70 Covariance matrices/matrix: characteristics of, generally, 78 decomposition, 242-243, 246-247 equity risk factor models, 337-338, 342, 357-358, 361-364, 387, 395 estimation, see Covariance matrix estimation factor model framework, 378 global equity factor model, 372 Covariance matrix estimation: alternative methods, 245-248 applications, generally, 224-227,

237-239 computations, 225 correlations and, 241-243, 248 decay rate, 236, 239-241, 243 financial data, 227-231 generalizations, 239-243 histories of different length, 243-245 normal distributions, 240-241 risk model, 248

using daily data, 232-235, 238, 248 volatilities, 225, 232, 241-243, 248 weighting observations, 235-237, 242-243 Credit ratings, 438, 441 Credit risk: implications of, 27, 251, 438, 445, 552

monitoring, 267-268 Credit-risk-free interest rates, 436 Credit spread, 30 Credit Suisse First Boston

(CSFB)/Tremont, 486, 495 Cross-portfolio pricing comparisons,

293 Cross product: defined, 60

matrix, equity risk factor model,

347-348 return attribution, 320-321 Cross-section modeling, equity risk factor models, 341, 345 Currencies, global equilibrium, 30, 56-75

Currency allocation strategy, 446

Currency asset exposures, 353 Currency contributions, return attribution: international portfolio, 320-322, 325

single region, 306 Currency effect, global equity risk factor model, 367 Currency exposure, equity risk factor models, 376-377 Currency forwards, 414, 446 Currency hedging, 104-105, 140-149,

441, 457 Currency markets, forecasts across valuation measures, 464 Currency overlay, 469 Currency risk, 355, 440-441 Currency selection, global tactical asset allocation (GTAA), 474 Currency surprise, 320-322 Custodians, 411, 468 Custody, 411

Customized investment plans, 410 Customized portfolios, 429 Cyclical industries, 31

Daily data, risk monitoring program, 216

Data collection, in valuation, 288

DAX equity index, 301

Decay rate, covariance matrix, 236,

239-241, 243 Default, 31, 438 Default premium, 338-339, 344 Deferred taxes, 542-543, 567 Defined benefit plans, 102, 488-489 Degree of confidence, 85, 87, 172-173, 190

Dependencies, in risk plan, 254-255 Depreciation, global equilibrium, 60-61

470-476 Developed markets, 93, 213, 371 Dilution effect, 296 Discount rates, 50 Disposal plans, 538, 542-543 Distressed debt investing, 442

Diversification:

active risk management, 199 levels, 104-105, 110 Dividend(s): implications of, 46, 52, 281, 548, 565

payout ratios, 48 reinvestment, 541 Dodd, David, 416 Dollar-weighted returns, 281 Domestic equities:

active risk management, 202 portfolio risk, 14-19 strategic asset allocation, 122-123 Dow, Charles Henry, 455-456 Downside scenarios, risk budgets, 257 Dow Theory, 456 Duration timing strategy, 444 Dynamic asset allocation, 113, 121, 125-126

Earnings growth, 48 Earnings quality anomaly, 421 Earnings to share price (E/P), 339-341, 359

Earnings-yield-gap timing model, 465 Economic and Monetary Union (EMU), 366

Economic growth, 247 Economic shocks, 366 Efficient frontier, 533-354, 561-562,

564, 571-573, 585, 587-591 Efficient market, 33, 42, 101 Efficient Markets Hypothesis, 456, 459

Efficient portfolio, 427-429 Eigenvalues, 346

Electronic communications networks

(ECNs), 432 Emerging markets, 46, 93, 160-162, 213

Emerging-market debt (EMD), 442, 450

Empirical analysis, 424

Employee demographics, implications of, 111 Energy prices, 30 Enhanced active management, 26

Enhanced block diagonal global equity factor model, 367-369, 372-373 Entity, after-tax returns, 543-544 Equilibrium approach, generally: benefits of, 3-6 Capital Asset Pricing Model (CAPM), 36, 77 Equilibrium expected returns, forecasting, 422 Equity allocations:

overfunded, 119, 120, 122, 125 underfunded, 118-121, 130 Equity index funds, 565 Equity index futures, 414, 470-471 Equity investments:

Capital Asset Pricing Model

(CAPM), 40 portfolio risk, 36-38 Equity long/short sector, hedge funds,

490, 494-495, 498 Equity market, 30

Equity market neutral, 490, 494-495, 498

Equity-only equilibrium, 79 Equity portfolio management (EPM): forecasts, 419-426 overview, 416-417 portfolio construction, 427-431 quantitative approach to, 418-419 results evaluations, 432-434 returns, forecasting, 417, 420-422 risk monitoring, 432-433 risks, forecasting, 417, 422-423 trading, 431-432 traditional approach to, 417-419 transaction costs, forecasting,

423-425 updating investment process, 432-434

Equity portfolio structure, 579-590 Equity premium puzzle, 48, 51 Equity risk, 130 Equity risk factor models: American depositary receipts

(ADRs), 355-356, 376 background, 341-342 covariance matrices, 361-364 currencies, 376-377

estimating factor returns, 356-359 factor-mimicking portfolios, 340,

359-361 factor returns and exposures,

338-340 futures, 355, 376 GDRs, 355-356, 376 global, 365-373 histories, 356

linear cross-sectional factor model,

348-355 observed factor returns, 342-344 overview, 334-335 portfolio definitions, 374-376 portfolio risk statistics, 377 risk estimation, 392-395 risk measurement, 378-392 risk sources, 373-378 simple, example of, 335-337 unobserved factor returns, 345-348 Equity risk premium (ERP): defined, 45

equilibrium estimates of, 48-53 frictions, 52 habit persistence, 52 historical perspective, 45-48 implications of, 550 investment policy and, 53-54 strategic asset allocation, 109 utility function, 50-52 Estate planning, 538-541, 544-545,

572-576, 590, 592 Estate tax(es), 537-538, 544-545, 568, 574-578

Estimation universe, 356-357, 393 Euro, 62, 142, 147, 151, 349 European Public Real Estate

Association (EPRA), 101-102 Event driven sector, hedge funds, 490,

494-495 Ex ante/ex post equity returns, 52 Exceptional active return, 304, 306 Excess returns, see Expected returns covariance matrix estimation, 227 implications of, 107 private equity, 523 risk budgeting, 447-448

Exchange-traded funds (ETFs), 25,

389-390 Expected active return, 303 Expected returns:

Black-Litterman global asset allocation model, 77-86 Capital Asset Pricing Model

(CAPM), 36 covariance matrix estimation, 226 credit risk and, 268 global equilibrium, 56-75 market portfolio construction, 100-101 modern portfolio theory (MPT),

12-13, 16-20, 23 risk budget, 255-256 uncorrelated assets, 161-168 Exposure matrix, 346, 393

Factor loadings, 338-339 Factor-mimicking portfolios (FMPs),

340, 359-361 Factor model, return attribution: contributions to returns, 331 global, 321-322 implications of, 247 linear, 303, 309, 311-319 Factor returns: contributions, 301, 304, 306 covariance matrix forecasts, 362-363 equity risk factor models, 338-341, 347

estimating, 356-359 global, 367 Fair value, 288-289, 294-296 Fama, Eugene, 45, 53, 344 Federal Reserve, 552 Fed model, 464 Feedback, indirect, 222-223 Fiduciaries, 408

Financial accounting controls, 252, 277

Financial budgets, 252, 257, 277 Financial institutions, risk management strategies, 28-29, 249 Financial planning, 277

Financial risk management, 28-29 Financial statements, 417 Financial theory, 4 Financial Times Stock Exchange

(FTSE), All World indexes, 91-92 Fiscal policy, 436

Fixed income arbitrage, 490, 494-495 Fixed income market, 74, 78 Fixed income portfolios:

active management strategies,

444-451 benchmarks, 442-444 risk budgeting, 446-451 risk sources, 435-442 Fixed-income securities, 99, 104-105,

130, 145, 555 Forecasting:

equity portfolio management (EPM),

417, 419-426 factor model framework, 378 global tactical asset allocation

264-266, 273 returns, 417, 420-422 risks, 417, 422-423 transaction costs, 423-425 Foreign bond portfolios, 140-142 Foreign exchange (FX), currency hedging, 145 Foreign exchange hedge, 60 Foreign exchange market, 349 Foreign exchange rates, 292. See also

Exchange rates Foreign market changes, 30 Forward contracts, 60, 319, 325, 468,

470, 472 Forward premium, 320, 322, 325 Foundation, 566, 569-570, 575-578, 590

401(k) plan, 543, 567, 575 Fouse, William, 456 Frank Russell Company, 313 Free float, 92, 94, 98 French, Kenneth, 45, 53, 344 Frictions, 52 FRM/MSCI, 487 FTSE 300, 92

FTSE 350, 427

Fundamental analysis, 402-403 Fundamental beta, 387-388. See also Beta

Fundamental factors, equity risk factor models, 338-339, 341, 345 Funding ratio, 128-130, 133-135 Futures accounts, 153 Futures contracts, 60, 376, 388, 459,

468, 470-472 Futures exchange and traded fund positions, measuring risk of, 388-390

Gamma exposure, 439 GDRs, 355, 376

General Agreement on Tariffs and

Trade (GATT), 366 Generalized autoregressive conditionally heteroscedastic (GARCH) processes, 245-246 General partners, 519 Geometric returns, 319 Germany:

equity market, 79-80, 82-84 European Public Real Estate Association (EPRA), 102 global equity risk factor model, 367

Gift tax, 537-538

Ginnie Mae (GNMA), 441

Global bond market, forecasting across using valuation measures, 464 Global bonds, Lehman Global Aggregate index, 98-100 Global capitalization weighted portfolio, 151

Global equilibrium expected returns: Capital Asset Pricing Model

(CAPM), 55-56 equilibrium condition, 70-75 exchange rates and, 61-66 general model, 57-61 matrix algebra, 63-64, 67-70, 74 optimal portfolio, 63-65 Global equities modeling: block diagonal factor model, 367-369, 371-372

combined single region model (SRM), 367-369, 371-373 comparison of, 369 enhanced block diagonal, 367-369, 372-373

global equity factor model, 367-371 Global equity, generally: diversification, 122-123, 130 factor model, 367-371 index, 20 Global equity markets:

forecasting across using valuation measures, 461, 463 forecasting within using valuation measures, 463 Global equity portfolio:

characteristics of, generally, 92, 365

local indexes, 95-98

Morgan Stanley Capital International

(MSCI) equity indexes, 93-97 Salomon Smith Barney Global Equity Index (SSBGEI), 91-93 Global factor model, 321-322 Global Industry Classification Standard

(GICS), 94, 350-351 Global interest rates, 445-446 Global markets, 14 Global minimum-variance portfolio, 87-88

Global multi-asset-class benchmark, 472 Global stock-selection portfolio, 463 Global tactical asset allocation (GTAA): asset class, 455, 459-461 benchmarks, 480-482 completion element, 455, 457-458 completion portfolio, 473-474 country predictability, 459-461 customization, 455, 479-480 empirical evidence for, 461-467 expectations, 478-481 global currency management, 469 history of, 455-457 implementation, 467-478 leverage, 476-478 manager selection, 481-482 overlay portfolio, 474-476 performance, 478-480 portable alpha strategy, 480-481

portfolio construction, 467-468,

479-480 program structure, 457-461 pure overlay element, 455, 458-459, 467

purpose of, 455 size requirements, 468-469 theoretical explanations for, 459-461 using forwards, 470, 472 using futures, 470-472 Goal-setting, in risk plan, 253 Goetzmann, Will, 46 Goldman Sachs Asset Management (GSAM): green zone, 270-272, 432 portfolio analysis and construction environment (PACE), 262, 264-267, 293, 298,304-306, 310-311, 391-392 red zone, 432-433 yellow zone, 432-433 Goldman Sachs Commodities Index, 103

Gordon growth model, 45 Government bonds, 45, 73, 98-99,

344, 436, 546-548, 565 Graham, Benjamin, 416, 434, 456 Grantor trust, 566-568, 570, 574-575, 587

Great Depression, 555 Green Sheet, 217-222, 272 Green zone events, 214, 216, 222,

270-273, 432-433 Grinold's Law, 458, 463-464 Gross domestic product (GDP), 46, 48, 93

Group weight, 307, 326 Growth factors, 436 Growth managers, 197, 213 Growth rate, 344 G-7, currency hedging, 147

Habit persistence, 52 Half-life, 236, 241, 243, 503 Heartland: High Yield Muni Bond, 292 Short Duration High Yield Mini, 292 Hedgefund.net, 504

Hedge Fund Research (HFR), 486 Hedge funds:

allocation development, 489-490 characteristics of, generally, 78, 103-105, 153, 286-287, 444, 502-504, 565 classifications, 505 evaluation framework, 488-489 fee structure, 503 funds of, 515

hurdle rate evaluation, 488, 494-500 implementing allocations, 490-494 information resources, 486-488, 504 investment strategy, 506 investment universe, 504-505 leverage, 487

management characteristics, 484-486 managerial style, 506 monitoring, 514

organizational structure, 507-508 overview, 501-502 people involved, 507 portfolio construction, 510-513 portfolio management, 501-515 potential advantages of, 483-486, 499

self-reporting biases, 486-488 track record, 508-510 Hedging, 28, 56, 73, 112, 474 Held-to-maturity portfolios, 436 Hennessee, 486

High-yield bond index, 338, 344 High-yield bonds, 438, 445 High-yield markets, 217 Hindsight bias, 418 Historical data:

active risk management, 193-195, 200, 208-210 covariance matrix estimation, 247 currency hedging, 147 optimal risk budget, 177-178,

181-183, 188 significance of, 30, 107, 109 Historical simulations, 265, 269, 413 Historical volatility, 31, 350, 438 Historic returns, 12, 546-550 Holding periods, 547-548, 558, 560, 582

Home bias, 145-146, 365-366 Hong Kong Monetary Authority

(HKMA), 461 Hopkins, Peter, 463 Hot spots:

equity risk factor models, 379-386 in risk management, 34-35 Human capital, 102 Hurdle rates: defined, 181, 484 hedge fund evaluations, 488,

494-500 portfolio risk, 18-21, 23

Ibbotson, Roger, 45, 47-48 Ibbotson Associates, 547 Illiquidity, 267, 503-504, 513, 526 Implementation shortfall, 425 Implied forward interest rates, 444 Implied hurdle rates, hedge funds,

494-499 Implied returns: currency hedging, 147-149 hedge funds, 493

risk budget development, 179-184 uncorrelated assets, 162-164 Implied views, in portfolio risk, 19,

22-23, 166 Implied volatilities, 246-247 Incentive fees, 289 Income, taxable, 565. See also

Ordinary income Income tax, 52, 534, 536, 543, 568 Independent valuation:

accounting agents, 289-290 importance of, 285-286 oversight group, responsibilities of,

286, 291-293 oversight philosophy, 285-291 price verification, 290 separate oversight, 290 Individual investors, active risk management, 196 Individual retirement accounts (IRAs),

52, 538 Industrial diversification, 366 Industry asset exposures, 350-351, 353-354

Industry classifications: asset exposures, 354, 356 global equity risk factor models, 366

Industry contributions:

equity risk factor models, 386 return attribution, 320-322, 325-326, 328 Industry effect, global equity risk factor models, 365-367, 370 Industry factors, equity risk factor models, 345 Inflation, 11, 30, 45, 344, 436-437, 540-541, 545, 547, 549-553, 564

Inflation risk, 57 Information ratio:

active risk management, 195, 199, 206-208

global equity markets forecasts, 461 global tactical asset allocation

(GTAA) portfolio, 479 performance measurement, 273, 275

risk budget development, 181, 185, 187, 189

Initial public offering (IPO), 519, 540 Institutional funds:

international diversification, currency hedging, 136-151 market portfolio, 91-103 strategic asset allocation, 104-135 uncorrelated return sources, 152-168 Institutional investors, active risk management, 196, 198 Institutional portfolios, 25 Insurance companies, 550 Insurance coverage, 254 Interaction effect, return attribution,

307-308 Interest rate risk, 436, 442, 552 Interest rates, 30, 49-50, 292, 549 Intermediate-term price momentum anomaly, 421 Internal control, 260, 289 Internal rate of return (IRR), 520-521 Internal rate of return (IRRATE), 281-282

Internal Revenue Service (IRS), 539,

568, 582, 587 International CAPM, 56, 66 International diversification: home bias and, 137-140 strategic asset allocation, 105 International equities, portfolio risk, 14-19

International portfolio, return attribution, 319-327 Intuition, 12, 22, 34, 36, 40, 62, 87,

119, 122 Investment Benchmark Reports (Venture Economics/Thomson Financial), 102 Investment Company Act of 1940, 287 Investment decision-making strategies,

10-11, 22-23, 29, 405-406 Investment horizon, 45, 470, 541-542, 555

Investment philosophy, 399-400 Investment plan: components of, 24, 254 implementation of, 25-27 monitoring, 27

size of, see Investment plan size Investment planning, 540 Investment plan size: costs, 408, 411-412 implementation impact on risk,

408-410 separate accounts vs. commingled vehicles, 410-411 Investment program implementation: asset allocation drift, 412-414 completion management, 414-415 overview, 407 plan size, 408-412 Investment style contributions, return attribution: international portfolio, 320-322,

326-327 single region, 307 Investment styles:

asset exposure, 351-353 hedge funds, 506 types of, 320-322, 326-327, 432 Investor myopia, 365-366

Japan:

covariance matrix estimation applications, 234 equity market, 84, 107, 162,

165-166 global equilibrium excess returns, 57-65

global equity risk factor model, 367

government bonds, 98 optimal portfolio construction, 107

strategic asset allocation, 160 TOPIX, 101, 427 Jorion, Philippe, 46, 469 J.P. Morgan Global Government Bond

Index, 477 Junk bonds, 438

Labor income, 102 Laddered portfolios, 437 Large-cap stocks, 198, 364, 425-426 Leaning against the wind, 466 Least squares regression, 370 Legal risk, 27, 251 Lehman:

Global Aggregate index, 98-100 Long Government and Credit Index,

115, 117, 124-125 U.S. Aggregate Index, 125, 444, 448

Leptokurtic distribution, 228 Leverage/leveraging: constraint, 87

global tactical asset allocation

(GTAA), 476-478 implications of, 276, 450, 569 private equity investments, 518, 524 Liability analysis, in strategic asset allocation: dynamic, 125-126 modeling, 111-112, 131-133 static, 113-115 uncertainty, 110-111 Life expectancy, 566 Likelihood functions, 241, 243 Limited partners, 519 Limited partnerships, 102

Linear cross-sectional factor model: asset exposures, 350-355 global framework, 349-350 local framework, 348-349 Linear factor model, return attribution: components of, 247, 303, 309 multiperiod attribution, 311-319 Linearity, in portfolio, 31, 100-101 Lintner, John, 36

Liquidation, private equity, 519-520 Liquidation mode, 542, 581-582 Liquidity, generally: awareness, 269 duration, 267 implications of, 472 risk, 27, 251 Local market asset exposure, 351-353 Log returns, 313-316 London InterBank Offer Rate (LIBOR),

74, 444 Long position, 21, 361, 484 Long Term Capital Management

(LTCM), 414, 461 Long-short portfolio, 359-360 Long-term investors, 555 Lottery, 11

Macroeconomic factors: defined, 48

equity risk factor models, 338-339,

341, 344 interest rate risk and, 436 yield curve risk, 437 Managed portfolio: defined, 374-375 risk measures, 378 Management costs, 411 Management fees, 25-26, 28, 154, 289

Management philosophy, 270 Manager selection:

asset-management approach,

400-402 fundamental analysis, 402-403 global tactical asset allocation, 481 investment decision making, 405-406

investment philosophy, 399-400 investment style, 401 qualitative analysis, 401 quantitative analysis, 404-405 self-classification, 401 triangulation, 403-404 Manager-selection team, 402, 405 Managerial styles: active, 26

structured vs. traditional, 193-197 Marginal contribution, portfolio risk, 19-21, 33, 38, 40, 161, 173, 200, 261, 263, 492-493 Mar-Hedge, 486 Market capitalization: asset exposure, 353-354 Black-Litterman global equilibrium approach, 79-80, 83 covariance matrix estimation, 225 equity risk factor models, 358, 360 free float, 92, 94, 98 global equilibrium, 59, 66, 70, 72-73

global equity factor model, 371 global equity portfolios, 92 Morgan Stanley Capital International (MSCI) global equity indexes, 93-94

risk premium, uncorrelated assets, 160

Salomon Smith Barney Global Equity

Index (SSBGEI), 93 significance of, 4, 6, 37, 40-41, 43 Market distress, 242 Market factors, equity risk factor models, 338, 341-344 Market inefficiency, 459 Market makers, 292 Market neutral, 444 Market-neutral hedge funds, 153, 583

Market portfolio: assets in, 101-103 construction of, 100-103, 388 defined, 374-375 global bonds, 98-100 global equity, 91-98 strategic asset allocation, 108

Market risk, 43, 154, 190, 251 Market segregation, 459 Market shocks, 241 Market size, equity risk factor models, 361

Market spread, 437

Market timing, 300-301, 304, 432,

444, 448, 456, 464, 476 Market value, 582 Markowitz, Harry, 12, 40 Mark-to-market (MTM), 388 Matrix algebra, global equilibrium,

67-70, 74 Matrix pricing, 289, 294 Maturity premium, 344 Maximum likelihood estimates, 243 Mean reversion, 554, 562, 564 Mean-variance optimization, 81, 131, 256

Merger arbitrage, 513 Merrill Lynch:

1-3-Year U.S. Treasury Index, 444 6-Month U.S. T-Bill Index, 444 Miller, Hayes, 463 Mispricing, 286, 295-296 Model risk, 260

Modern portfolio theory (MPT): common applications, 10-13 cost-benefit analysis, 9-10 insights, generally, 32-33 return on investment, 8, 11-12 as risk management strategy, generally, 7-9, 12 size of return, 13, 22 Modified Bank Administration

Institute (modified BAI) method, 281

Modified Dietz method, 281, 283 Momentum, generally: factor, 355

GTAA forecasts, 465-467 Monetary policy, 31, 436 Money market securities, 10, 550, 555, 565

Monte Carlo simulation, 128-130,

229-230, 265-266, 269 Monthly data, risk monitoring program, 214, 216

Moody's, 438

Morgan Grenfell Asset Management, 285

Morgan Stanley Capital International (MSCI):

All Country World Index (ACWI),

91-93, 95, 98 covariance matrix estimation, 228

EAFE, 78, 177, 188, 427 emerging markets index (EMF), 93

Equity Index Series, 93-94 Global Industry Classification

Standard (GICS), 351 Greece index, 93 index construction, 94, 97 Morocco, 93

World index, 94-96, 98, 476 Mortality rates, 111 Mortgage-backed securities (MBS),

99,435,439-440, 442, 445 Mortgage pools, 440-441 Mossin, Jon, 36 Multimanager portfolios, 411 Multiperiod return attribution: linking returns, 311-313 linking sources of returns, 313-319 Multiple-asset portfolios, 22 Multivariate analysis, 421 Multivariate normal distribution,

227-228, 239 Municipal bonds, 538, 565, 593 Mutual funds, 103, 286, 295-296, 400, 410-411

Nasdaq Composite Index, 282-283 Nationally recognized statistical rating organization (NRSRO), 438 Natural resources, 103, 105 Negative alpha, 510 Negative RCTE, 382 Nelsons Database, 177-178, 479-480 Net asset value (NAV), 285-286,

295-296, 514-515 New York Stock Exchange, 295 Nikkei 225, 92

Noise:

covariance matrix estimation, 238 volatility, 111-112, 114-115, 118, 120

Nominal returns, 549-550, 553 Nonestimation universe, 357 Nonlinear portfolio, 31 Normal distribution, 32, 227-228,

239-241, 243 Normalized returns, 271 North America Free Trade Agreement

(NAFTA), 366 Notional leverage, 478 Null hypothesis, 53

Objectives, long-term, 590 Oil, 103

One-period returns, 313-315, 318-319 Opening price, 431 Operational risk, 27, 251 Optimal asset allocation, wealth creation, 571-578 Optimal portfolio:

Capital Asset Pricing Model

(CAPM), 40-43 characteristics of, generally, 12, 16,

23, 33, 39-41 construction, 297 covariance matrix estimation, 226 global equilibrium, 66, 70 weights, in strategic asset allocation, 106

Option pricing, 246, 439 Ordinary income, 548, 577 Ordinary least squares (OLS)

regression, 357-358 Organizational culture, 259 Oscillation, implications of, 228-229,

238, 555 Overconfidence, 418 Overlay, see Pure overlay Overreaction, long-term, 459-460 Over-the-counter (OTC) securities, 289

Partnerships, private equity, 519-521 Passive index portfolios, 25, 435 Passive management, 26, 202-203, 206-210, 480, 588

Passive portfolios, 581-582 Peer group, in performance measurement, 276-278 Pension funds:

asset distribution, 112-113 funding probabilities, 128-130 liabilities, 52, 111, 125-126 overfunded, 127, 130 payout structure, 125-127 required returns, 126-128 risk plan for, 255 static analysis, 113-115 tax-exempt, 550 underfunded, 126, 128, 130 Percent returns, 313-315 Performance attribution, 260, 273, 299

Performance contribution, 299 Performance measurement, calculation of, 280-281. See also Performance measurement tools Performance measurement tools: alpha, 275-277 benchmarks, 275-276 green zone, 270-273 information ratio, 273, 275 meaningfulness of, 269-270 multiple, 268-269 peer group, 276-277 returns, attribution of, 273 Sharpe ratio, 273, 275 Planning, in risk management, 252

Plan Sponsor Network (PSN), 193

Plan sponsors:

active management, 213 functions of, 211-212 risk monitoring, 221 Portable alpha, 480-481, 491 Portfolio analysis:

alternative assets, 153-154 risk contributions, 156, 162 risk premium, 154-155 Portfolio diversification, 9, 11, 13 Portfolio management:

characteristics of, generally, 28 wealth generation and, 590-592

Portfolio optimization:

portfolio construction and, 417,

428-4SG, 467-468 strategy overview, 19-2G Portfolio risk:

currency hedging, 145 decomposition of, S4-S5 implications of, 1S-14, 17, 21 measurement, S78-S79 Portfolio valuations, periodic reviews of, 29S

Positive RCTE, S82 Post-earnings-announcement drift,421, 46G

Practice of Risk Management, The

(Litterman/Gumerlock), 251, 259 Predicted beta, S87 Predicted R-squared, S88 Preferred stock, 565 Prepayment duration, 44G Prepayment risk, 4S9-44G, 442 Price comparisons:

against independent model prices,

292-29S pricing sources, 291-292 Price/earnings (P/E) ratio: annual returns, 555 estimated risk premium, 45 expansion, 47, 52 growth, 47 historic returns, 546 Price reversals, 422 Price verification, 29G Pricing:

methodologies, 289 override/manual price procedures, 289

valuation oversight philosophy, 286-288 Pricing in, defined, 444 Principal component analysis (PCA),

S45-S48 Principal package trading, 4S2 Private equity, see Private equity investments characteristics of, 25, 1G4-1G5 defined, 1G2

market portfolio and, 1G2-1GS

Private equity funds, 565 Private equity investments:

characteristics of, generally, 516-517, 530

historical returns, 521-523 mechanics of, 519 optimal allocation examples,

525-528 purpose of, 516-517 return sources, 523-525 returns statistics, 519-520 risk, 518

suboptimal allocation, 528-530 types of, 517-519 valuation, 519-520 Private wealth:

after-tax results, investing for,

533-545 after-tax returns for U.S. stocks, bonds, and bills, 546-564 asset allocation and location, 565-578

equity portfolio structure, 579-593 Probabilities, in risk management, 31 Probability distributions, 32, 81, 83,

227-228, 239 Productivity growth, 50 Profitability, risk-adjusted, 256 Proxy universe, 357 Public equities, 565 Public equity market, 102, 518 Pure overlay, global tactical asset allocation (GTAA), 455, 458-459, 467

Quantitative analysis, management selection, 404-405 Quantitative management, equity portfolio management (EPM), 418-419 Quantitative modeling, 87

RACS, see Risk-adjusted change in surplus (RACS) Raw exposure, 350 Real estate, generally: investments, 25, 78, 100-105 publicly traded, 101-103

Real estate investment trusts (REITs),

409,565,567 Real interest rate, 344 Reallocation, 538 Rebalance strategy, 413-414, 417 Recession, impact of, 31 Recruitment, management selection process, 403-404 Red zone events, 214, 216, 432-433 Reference checks, management selection process, 403-404 Refinancing, 440 Regression analysis: characteristics of, 422 covariance matrix estimation, 244-245

cross-sectional, 309, 345, 357-360, 393

equity risk factor models, 339, 346-347

performance measurement, 275-276 Relative marginal contribution to tracking error (RCTE), 381-382 Relative marginal factor contribution to tracking error (RFCTE), 384-385 Relative specific contribution to tracking error (RSCTE), 385 Relative value sector, hedge funds, 490, 494

Remedial planning, 254 Reoptimization, 106 Repurchase agreements, 375 Residual return, 174, 327-329 Residual risk, 176, 393 Retirement planning, 575 Return attribution:

algorithms, to align official and estimated returns, 328-329 asset grouping, 298, 306-311,

332-333 defined, 297, 299 factor model, 298, 301-306, 309, 331

international portfolios, 319-327 in performance measurement, 273,

327-328 purpose of, 298-300 residuals, 327-329

returns computation, 300-301,

331-333 single region (local model), 301-319 Return-free strategy, 202 Return on equity (ROE), 47-48,

253-254, 256-258, 278, 423 Returns, see specific types of returns after-tax, 541-544 computation of, 283-284 dollar-weighted, 281 normalized, 271 risk capital, 277 stocks vs. bonds, forecasts using valuation measures, 464-465 time-weighted, 282-283 uncorrelated assets, see Returns for uncorrelated assets Returns for uncorrelated assets:

optimal portfolio weights, 162-163,

165-166 optimal risk allocations, 164-165 portfolio analysis, 156-160 risk decomposition, 161, 164, 166

strategic asset allocation, 163-168 Returns on risk capital (RORC),

253-254, 256-258, 278 Risk, see specific types of risk allocation, 27, 172 characteristics of, 534 defined, 249, 277 forecasting models, 262, 264-266 sources of, generally, 33-34, 152-168, 251, 313-319, 373-378, 435-442, 523-525 types of, 27, 251 Risk-adjusted change in surplus

(RACS), strategic asset allocation,

114-115, 120-123, 130-131 Risk and return assumptions:

active risk management, 201 strategic asset allocation,

115-125 Risk aversion:

Black-Litterman global equilibrium approach, 83 global equilibrium and, 63, 72, 75

49-51, 56, 109, 155, 179 private equity investments, 525 Risk budget/budgeting:

active management strategies,

446-451 active risk level, 171-185 active risk spectrum, 192-210 covariance matrix estimation, 248 data analysis, 176-179 development of, 24, 26-27, 171-173 equity risk factor models, 334-395 example of, 256-257 global tactical asset allocation

(GTAA), 476 hedge funds and, 512 implied confidence levels, 185-190 implied returns, 179-184 independent valuation, 285-296 investment policy, 185-190 optimal active risk budget development, 171-191 optimal allocation, 14 optimality and, 173 and portfolio, 429 purpose of, 255-256, 277-278 return attribution, 297-333 risk management, total fund level, 211-223

risk monitoring, 221-222, 249-284 risk/return analysis, 13 security selection, 221 separate investment accounts, 410 uncorrelated assets, 166 views, 185-190 Risk capital, 253-254, 257, 262-264, 277

Risk contributions, 156, 162 Risk culture, 260-261 Risk decomposition, see Portfolio risk, decomposition of analysis, 269

covariance matrix estimation, 226 equity risk factor models, 383, 391 GTAA portfolio, 475-476 implications of, 34-35, 147, 164, 166, 172, 199, 224, 254,263-264, 391-392

return attribution and, 298-299 risk monitoring program, 221-222 uncorrelated assets, 161 Risk diversification standards, 277 Risk estimation, 392-395 Risk exposure, 351 Risk footprint, 215 Risk-free assets, 37, 49 Risk-free rate, 39, 48, 58, 114-115,

159, 175, 303 Risk-free strategy, 202 Risk-free yield curve, 436 Risk function, 15-16 Riskless asset, 45 Risk management: benchmarks, 28 decomposition of risk, 34-35 dimensions of, 251, 277 program implementation, see Risk monitoring program purpose of, 27-28, 35 risk budget, see Risk budget/budgeting risk plan, 253-255 significance of, 29-30 strategic asset allocation, 108-109 strategies, generally, 7-9, 12 stress test, 30-32 three-legged stool, 253-258 utility function, 32-33 Value at Risk (VaR), 28-29, 35 volatility, 35 Risk management unit (RMU): credit risk monitoring, 268 examples of, 261-266 formation of, 258-259 objectives of, 251, 260-261 performance attribution, 273 performance measurement, 271, 275 philosophies/processes, 270, 279-280 risk budget, 278 Risk measurement: asset allocation, 24-25 benchmarks, 25 risk budget, 24-27 risk tolerance, 25 significance of, 14-15, 24-26 source of risk, 33-34

Risk minimization strategies, 21-23,

156-157 Risk monitoring program: credit risk, 267-268 Green Sheet, 217-222 green zone, 214, 216, 222, 270-273,

432-433 implementation of, 212 performance measurement,

249-252 purpose of, 212, 251, 257-258 rationale, 258-259 red zone, 214, 216, 432-433 risk budget, 221-222 yellow zone, 214, 216, 271, 273, 432-433 Risk plan, 253-255 Risk premiums:

global equilibrium, 75 implications of, 42-43, 156 risk budget development, 183 uncorrelated assets, 154 Risk reduction strategies, 152, 534 Risk/return trade-offs, 115, 120, 154,

520, 553 Risk tolerance, 25, 42-43, 57 Roll, Richard, 100 Rolling window technique, 229-230 R-squared statistics, equity risk factor models, 343-344, 388 Rule-based portfolio, 429-430 Russell iShares, 389 Russell 1000, 427 Russell 2000, 188, 427 Russell 2000 Value Index (R2000V), 299

Safe asset allocation, 552, 554, 564 Salary growth, implications of, 111 Salomon Smith Barney (SSB) Developed World index, 93 Emerging Composite index, 93 Global Equity Index (GEI), 91-93, 95-96, 98 S&P 500, 30, 97, 196-197, 306, 328, 355, 388-389, 428, 464, 508, 510, 512

Satellite portfolio, 582-586

Secondary market, 437

Sector allocation strategy, 445

Sector contributions, return attribution,

320-322, 325-326, 328 Sector risk, 437-438 Securities and Exchange Commission (SEC), 285, 287-288, 290, 296, 502

Securities selection:

global equity indexes, 97 risk budgeting, 447-448 strategies, 445 Security-specific risk, 441-442 Selective perception, 418 Self-insurance, 254 Sell signals, modern portfolio theory

(MPT), 17-20 Senior leadership, functions of, 255 Senior management, functions of: risk management, 260 valuation policies, 289-290 Serial correlation, covariance matrix estimation, 233, 237-239, 244 Settlement risk, 251 Shadow price, 249, 255 Sharpe, William F., 33, 36 Sharpe ratio:

currency hedging, 151 expected returns, 164 global diversification, 122 implications of, generally, 33, 75,

105,113-114 implied, 166

performance measurement, 273, 275

strategic asset allocation, 110, 112, 120

uncorrelated assets, 155, 158-159, 163-166, 168 Short positions, 22, 28, 361 Short sales, 441, 502 Short-term price reversal anomaly, 421

Shrinkage, portfolio construction, 467

Siegel's paradox, 61-63, 69

Single region return attribution: asset grouping methodology,

Millionaire Mindset Affirmation

Millionaire Mindset Affirmation

You already recognize that rich individuals think differently than middle class or poor individuals in every aspect of life. But particularly when it comes to money. That's why they're rich. Their selections and decisions just by nature bring about riches.

Get My Free Ebook


Post a comment