• Duration 10 weeks
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    Diana Muriuki

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    Advanced Level

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UNIT DESCRIPTION This paper is intended to equip the candidate with the knowledge, skills, and attitudes that will enable him/her to apply advanced financial techniques and methods in portfolio management. LEARNING OUTCOMES A candidate who passes this paper should be able to: • Develop investment policy statement for individual and institutional investors • Construct a portfolio using different asset classes • Analyse different strategies used to manage a portfolio of different asset classes • Apply trade execution decisions and techniques in portfolio management • Undertake portfolio monitoring and rebalancing processes • Evaluate the performance of a portfolio.

Paper No. 15 Advanced Portfolio Management

This paper is intended to equip the candidate with the knowledge, skills and attitudes that will
enable him/her to apply advanced financial techniques and methods in portfolio management.

A candidate who passes this paper should be able to:
• Develop investment policy statement for individual and institutional investors
• Construct a portfolio using different asset classes
• Analyse different strategies used to manage a portfolio of different asset classes
• Apply trade execution decisions and techniques in portfolio management
• Undertake portfolio monitoring and rebalancing processes
• Evaluate the performance of a portfolio.

1. Capital market forecasts
1.1 The application framework
1.1.1 Overview of capital market forecasts and approaches
1.1.2 Role of and a framework for capital market forecasts in the portfolio
management process, challenges in developing capital market forecasts
exogenous shocks and their effect on economic growth
1.1.3 Application of economic growth trend analysis to the formulation of capital
market forecasts, approaches to economic forecasting, effect of business
cycles affects short- and long-term forecasts, relationship of inflation to
the business cycle and the implications of inflation for cash, bonds, equity,
and real estate returns
1.1.4 Monetary and fiscal policy effects on business cycles, macroeconomic,
interest rate, and exchange rate linkages between economies.

1.2 Forecasting asset class returns
1.2.1 Approaches to setting forecasts for fixed-income returns, risks faced by
investors in emerging market fixed-income securities and the country risk
analysis techniques used to evaluate emerging market economies;
1.2.2 Approaches to setting forecasts for equity investment market
returns, risks faced by
1.1.3 Economic and competitive factors effect on forecasts for real estate
investment markets and sector returns;
1.1.4 Forecasting exchange rate volatility;
1.1.5 Changes in the component weights of a global investment portfolio based
on trends and expected changes in macroeconomic factors.

2. Managing individual investor portfolios and institutional investors Portfolio:
2.1 Individual investors:
2.1.1 Overview of investor characteristics: situational profiling (source of wealth,
measure of wealth, stage of life); psychological profiling (traditional
finance, behavioural finance, personality typing)
2.1.2 Investment policy statement for an individual investor
2.1.3 Strategic asset allocation for an individual investor: Monte Carlo
simulation in personal retirement planning.

2.2 Institutional investors:
2.2.1 Overview of pension funds: defined-benefit and defined-contribution
plans; pension fund risk tolerance; defined benefit and defined
contribution investment policy statement; risk management
considerations; hybrid pension plans; employee share ownership plans
2.2.2 Other institutional investors: Foundations, endowments, Insurance
industry (life and non-life insurance companies), banks, investment
intermediaries and other institutional investors; their background and
investment setting.

3. Asset allocation
3.1 Overview of asset allocation: role of asset allocation in portfolio management,
governance structures, articulation of investment objectives, allocation of rights
and responsibilities, governance audit, strategic versus tactical asset allocation;
importance of asset allocation in portfolio performance; steps involved in
establishing an appropriate asset allocation
3.2 Asset allocation and investors and return objectives: dynamic versus static asset
allocation; factors affecting asset allocation policy (loss aversion; mental
accounting; fear of regret); return and risk objectives in relation to asset
allocation, economic balance sheet and asset allocation
3.3 Selection of asset classes: criteria for specifying asset classes; inclusion of
international assets (developed and emerging markets)
3.4 Optimisation approaches to asset allocation: mean-variance approach (Its
application when adding an asset class in an existing portfolio); resampled
efficient frontier; experience-based approaches; asset only, asset/liability
management (ALM);); Black – Letterman approach: Monte-Carlo Simulation
3.5 Nondomestic equities and bonds: Their associated risks, costs and opportunities
3.6 Conditional return correlations: their importance when evaluating the
diversification effects of non-domestic investments
3.7 Integrating a segmented market with a global market: expected effects on share
prices expected returns, and return volatilities
3.8 Formulation and justification of minimum-variance frontier given investment
policy statement and capital market expectations.
3.9 Asset allocation with practical constraints.

4. Fixed income portfolio management
4.1 Use of liability as a benchmark and use of bond index as a benchmark with
respect to investment objectives
4.2 Managing funds against a bond market: classification of strategies (pure bond
indexing/full replication approach, enhanced indexing and active investing, fullblown); selection of a benchmark bond index and factors to consider (market
value risk, income risk, liability framework risk); use of bond market indices
4.3 Techniques used to align the risk exposures of the portfolio with those of the
benchmark bond index: duration matching technique, key rate durations
4.4 Assessment of the risk and return characteristics of a proposed trade: total return
analysis, scenario analysis
4.5 Bond immunisation strategy: its formulation and evaluation under various interest
rate scenarios
4.6 Spread duration and its importance
4.7 Extension of classical immunisation theory: introduction of contingent
4.8 Risks associated with managing a portfolio against a liability structure: interest
rate risk, contingent claim risk, cap risk
4.9 Immunisation strategies for single liability, multiple liabilities and general cash
flows: their advantages and disadvantages
4.10 Immunised portfolios: risk immunisation and return maximisation
4.11 Cash flow matching: its use in funding a fixed set of future liabilities; its
advantages and disadvantages.

5. International and emerging market fixed-income portfolio management strategies
5.1 Effect of leverage on portfolio duration and investment returns
5.2 Use of repurchase agreements (repos) to finance bond purchases: Factors
affecting the repo rate
5.3 Measures of fixed income portfolio risk: standard deviation, target semi variance,
shortfall risk and value at risk (VaR)
5.4 Use of futures instead of cash market instruments to alter portfolio risk
5.5 Formulation and evaluation of an immunisation strategy based on interest rates
5.6 Use of interest rate swaps and options to alter portfolio cash flows and exposure
to interest rate risk; use of credit derivative instruments to address default risk,
credit spread risk and downgrade risk in the context of fixed income portfolio
5.7 Potential sources of excess return for an international bond portfolio
5.8 Effect of change in value for a foreign bond when domestic interest rates change,
and the bond’s contribution to duration in domestic portfolio, given the duration of
the foreign bond and the country beta
5.9 Hedging currency risk in international bond markets; break-even spread analysis
in seeking yield advantages across international bond market; investing in
emerging market debt.

6. Equity portfolio management
6.1 Role of equity in the overall portfolio
6.2 Equity investment universe; segmentation by size and style, segmentation by
geography, segmentation by economic activity.
6.3 Equity investment approaches: passive approach; active approach; semi-active
(enhanced-index) approach; their relevance with respect to expected active
return and tracking risk
6.4 Weighting schemes used in the construction of major equity market indices and
the biases associated with each
6.5 Passive equity investing: alternative methods for establishing passive exposure
to an equity market; indexed separate or pooled accounts, index mutual funds,
exchange-traded funds, equity index futures and equity total return swaps
6.6 Approaches to constructing an indexed portfolio: full replication, stratified
sampling and optimisation
6.7 Active equity investing: equity investment–styles classifications and risks
associated with each; techniques for identifying investment styles; equity style
indices; equity style box analysis and style drift; long–short and long-only
investment strategies; ‘equitised’ market-neutral and short-extension portfolios;
sell disciplines/trading of active investors
6.8 Semi-active equity investing (enhanced-index): derivatives-based and stock-based enhanced indexing strategies
6.9 Managing a portfolio of managers: core-satellite approach to portfolio
construction; effect of adding a completeness fund to control overall risk
6.10 Components of total active return (“true” active return and “misfit” active return)
and their associated risk measures; alpha and beta separation as an approach to
active management;
6.11 Identifying, selecting, and contracting with equity managers
6.12 Structuring equity research and security selection: top-down and bottom-up
approaches to equity research.

7. Alternative investments portfolio management
7.1 Introduction to alternative investments portfolio management
7.2 Selection of active managers of alternative investment scheme
7.3 Alternative investment benchmarks: construction and interpretation; benchmark
7.4 Return enhancement and risk diversification effects of adding an alternative
investment to a reference portfolio (for instance a portfolio of bonds and equity
7.5 Venture capital: Major issuers and suppliers; purpose of venture capital; buyout
funds; use of convertible preferred stock in direct venture capital investment
7.6 Private equity fund: Typical structure and timelines; formulating private equity
investment strategy
7.7 Commodity investments: Direct and indirect commodity investment; components
of return for commodity futures contracts; role of commodities in a portfolio
7.8 Hedge funds: Typical structure; high water- mark provisions; fund-of-funds;
performance and evaluation
7.9 Managed futures: Trading strategies; role in a portfolio
7.10 Distressed securities: Risks associated with investing in distressed securities
including event risk, market liquidity risk, ‘J-factor’ risk

8. Currency portfolio management
8.1 Effects of currency movements on portfolio risk and return
8.2 Strategic choices in portfolio management
8.3 Active currency trading strategies based on economic fundamentals, technical
analysis, curry trade, and volatility trading
8.4 Adjusting the hedge ratio using forward contracts and foreign exchange (FX)
8.5 Trading strategies used to reduce hedging costs and modify the risk-return
characteristics of a foreign currency portfolio
8.6 Portfolios exposed to multiple foreign currencies: use of cross-hedges ratio,
macro-hedges ratio, minimum-variance-hedge ratio
8.7 Challenges for managing emerging market currency exposures

9. Execution of portfolio decisions
9.1 The context of trading: market microstructure: order types and their price and
execution uncertainties, their effective spread, and their quoted bid-ask spread;
types of markets and their quality; roles of brokers and dealers
9.2 Costs of trading: transaction costs components (explicit and implicit costs);
implementation shortfall and volume weighted average price (VWAP) as
measures of transaction costs; use of econometric methods/models in pre-trade
analysis to estimate implicit transaction costs
9.3 Major types of traders: their motivation to trade, time versus price preferences
and preferred order types; major trading tactics; algorithmic trading strategies
and determining factors including order size, average daily trading volume, bid–
ask spread and the urgency of the order
9.4 Trade execution decision and tactics: meaning and criteria of best execution;
firm’s investment and trading procedures, including processes, disclosures and
record-keeping with respect to best execution
9.5 Role of ethics in trading

10. Portfolio monitoring and rebalancing
10.1 Monitoring: Fiduciary’s responsibilities in monitoring an investment portfolio;
monitoring of investor circumstances, market/economic conditions, and portfolio
holdings; revisions to an investor’s investment policy statement and strategic
asset allocation, given a change in investor circumstances
10.2 Rebalancing: Benefits and costs of rebalancing a portfolio to the investor’s strategic asset allocation; calendar rebalancing; percentage-of-portfolio rebalancing;
optimal corridor width of an asset class; target portfolio rebalancing versus
allowed range portfolio rebalancing; rebalancing strategies (linear, concave, and
convex rebalancing strategies); constant mix, buy-and-hold, and constant
proportion portfolio insurance (CPPI) rebalancing strategies

11. Evaluating portfolio performance
11.1 Importance of performance evaluation from the perspective of fund sponsors and
the perspective of investment managers
11.2 Components of performance evaluation: performance measurement,
performance attribution and performance appraisal
11.3 Performance measurement: total, time-weighted, money-weighted rates of
return, linked internal rate of return and annualized return
11.4 Benchmarks: concept of a benchmark; properties of a valid benchmark; types;
steps involved in constructing a custom security-based benchmark; validity of
using manager universes as benchmarks; tests of benchmark quality; hedge
funds and hedge fund benchmarks
11.5 Performance attribution: inputs for micro and macro attribution; use of macro and
micro performance attribution methodologies to identify the sources of
investment performance; use of fundamental factor models in micro performance
11.6 Performance appraisal: risk-adjusted performance measures, including (in their
ex-post forms) alpha, information ratio, Treynor measure, Sharpe ratio and
Modigliani-Modigliani measure (M2); incorporation of portfolio’s alpha and beta
into the information ratio, Treynor measure, and Sharpe ratio; use of
performance quality control charts in performance appraisal
11.7 Practice of performance evaluation: noisiness of performance data; manager
continuation policy decisions
11.8 Investment manager selection; framework for investment manager search and
selection, type I and type II errors in manager selection, elements of manager
search and selection, capture ratios and drawdown in manager evaluation,
qualitative elements of manager due diligence, investment personnel investment
decision-making process

12. Performance Standards
12.1 Introduction to the Performance Standards; objectives, key characteristics, and
scope, benefits to prospective clients and investment managers; fundamentals of
compliance with the performance standards, requirements, and recommendations
of the performance standards with respect to input data, accounting policies
related to valuation and performance measurement;
12.2 Role of performance standards with respect to return calculation methodologies,
treatment of external cash flows, cash and cash equivalents, and expenses and
12.3 Performance standards and composite return calculations, methods for asset-weighting portfolio returns; composite construction and portfolio management,
role of investment mandates, objectives, or strategies in the construction of
composites, role of performance standards, and composite construction;
switching portfolios among composites, timing of the inclusion of new portfolios in
composites, and the timing of the exclusion of terminated portfolios from
12.4 Performance standards requirements for asset class segments carved out of
multi-class portfolios, performance standards, and disclosure requirements,
including fees, the use of leverage and derivatives, conformity with laws and
regulations that conflict with the global standards, and non-compliant performance
periods; performance standards presentation and reporting (timeframe of
compliant performance periods, annual returns, composite assets, and
12.5 Merits of high/low, range, interquartile range, and equal-weighted or asset-weighted standard deviation as measures of the internal dispersion of portfolio
returns within a composite for annual periods
12.6 Investments that are subject to performance standards for real estate and private
equity; provisions of performance standards for real estate and private equity;
12.7 Performance standards for Wrap fee/ valuation hierarchy of the performance
standards principles
12.8 Advertisements compliance with the performance standard guidelines.

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