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  3. Rijksuniversiteit Groningen (RuG)
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  5. Institutional Investment Management (EBM822A05)

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All-in-one: Summary, Lecture notes & Flash cards on Institutional Investment Management
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This document was carefully drafted to include notes on the course's reading material, and commentary on the lecture slides. It is written in the Cornell Method: it includes lecture notes on the right panel, cue cards on the left panel, and the summary of each lecture on the bottom panel on each of...

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  • 2 april 2024
  • 46
  • 2023/2024
  • Overig
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Voorbeeld van de inhoud

L1 - Intro
vrijdag 17 november 2023 08:59


Title: L1 - Intro

• Grading:
• 75% exam (min. 4.5)
• 25% case studies (3)
○ Case 1 (investment plan): 1/3
▪ a: investment plan including…
1) Investment objectives
 According to what the case demands
◊ If market goes up, we want returns of the market
◊ If market goes down, we want cash
 Investment philosophy:
◊ Check: J. Minahan (2006). The role of investment
philosophy in evaluating Investment managers.
◊ Suggestion: valuation, business cycle, sentiment.
 Valuations are mean reverting slowly: crucial to
long-term returns.
 Business cycle are mean reverting around
potential growth: determine medium-term
returns.
 Sentiment is chiefly trend-based and contrary in
the extreme: significant for short-term returns.
2) Description of the investment policy and process
 Get your alpha thesis: are you better at analyzing earnings,
discount rates?
– How can you make a process that is repeatable,
communicated, transparent, etc.
– For those who believe in market efficiency: no need to
do fundamental analysis.
 Then if there's no value in active management,
you need to think of sth else that allows to beat
the market.
3) Composition of the start-up portfolio with motivation for security
selection
 Show what the initial portfolio looks like.
– Why based on your philosophy this portfolio will do
well in the next weeks.
4) Criteria for buying and selling during the game and dashboard for
monitoring
 Beware of disposition effects: sell winners to soon and
selling losers too late.
 Clearly define what process triggers to buy/sell.
– In other words: what would make you enter/exit
positions.
5) A quantified projection/forecast of the target return of the start-
up portfolio.
 Give an idea of the expected return (what the portfolio will
deliver).
▪ b: Investment game
□ From today on we can access the portfolio and start trading.
○ Case 2: 1/3
○ Case 3: 1/3

• Role of financial market: provide capital
WR the 3 roles of


IIM Page 1

, • Role of financial market: provide capital
WR the 3 roles of • Informational role: capital flows to companies and countries with best prospect
financial markets?
○ Best quality companies/countries have lowest cost of capital
• Consumption timing: use securities to store wealth and transfer consumption to the
future
• Allocation of risk: investors can select securities consistent with their tastes for risk,
which benefits the firms that need to raise capital as security can be sold for the
best possible price

• Investment process:
• Portfolio: collection of investment assets:
WI a portfolio? • 2 approaches:
○ Top down: asset allocation.
WR the 2 approaches to
constructing ▪ More based on economics
portfolios? ▪ Choice among broad asset classes
▪ Asset allocation followed by security analysis to evaluate which
particular securities to be included in the portfolio
○ Bottom up: security selection
▪ Choice of securities within each asset class
▪ Investment based solely on the price-attractiveness, which may result in
unintended heavy weight of a portfolio in only one or another sector of
the economy

• Markets are competitive:
• Risk-return trade off: if you want a higher E(return), you assume a higher risk.
WD the risk-return ○ Higher-risk assets are priced to offer higher expected returns than lower-risk
trade off mean? assets.
• Efficient markets: in fully efficient markets, prices quickly adjust to all available
WD efficient markets information.
mean? ○ Classical notions of market efficiency were laid out by Fama (1970):
▪ Weak form: can't predict returns using historical prices
WR the 3 forms of ▪ Semi-strong: can't predict returns using all publicly available information
market efficiency? ▪ Strong: can't predict using private information
Describe them… ○ Implications of the EHM for investors: to the extent that speculative trading is
costly, speculation must be a loser's game
WR the implications of ○ The EMH has been refined over the past several decades to reflect
market efficiency for information, transactions, financing, and agency costs. Many behavioral
investors?
explanations have the same effect and some frictions are modeled as
behavioral biases.
○ Efficient vs inefficient: read paper 'The paradox of skill'

• Portfolio management alternatives
• Passive management:
WR the 2 portfolio ○ Holding a highly diversified portfolio
management ○ No attempt to find undervalued securities
alternatives?
○ No attempt to time the market
WR the features of • Active management:
passive management? ○ Finding mispriced securities
WR the features of ○ Timing the market
active management? ○ Catch 22: Without active management, there is no mispricing correction.
▪ Then, the market would be deviating from its intrinsic value
WI active management
essential? • Impact investment excellence programme:
• Theory of change for impact investments with focus themes climate biodiversity and
nutrition.
• Review attachment in email.


Summary: The role of financial markets is to allocate capital to its most effective uses. They do this by playing: (i) an
informational role (best prospects get access to capital); (ii) intertemporal consumption (savings allow to postpone consumption,


IIM Page 2

,informational role (best prospects get access to capital); (ii) intertemporal consumption (savings allow to postpone consumption,
and loans allow to advance consumption of future wealth); (iii) allocation of risk: investors can choose securities that align with
their risk preferences. There are 2 ways of constructing portfolios: (i) Top-down asset allocation: ground on economics to choose
among broad asset classes, then choosing which assets to hold within classes; (ii) Bottom-up: asset picking based on price-
attractiveness - may lead to overexposure to an asset class. Generally, ↑risk=↑return. Efficient markets hypothesis: prices adjust
quickly to available information (e.g.: weak, semi-strong, strong form). EMH suggests that speculation is a loser's game. There are
2 portfolio management strategies: (i) passive: hold a diversified portfolio and forget about market timing and stock picking; (ii)
active: focus on market timing and stock picking.




IIM Page 3

, L2a - Factor Theory
vrijdag 17 november 2023 11:20


Title: L2 - Factor Theory

Intro FF 3-factors
Is factor theory an
extension of the CAPM? • It is not the CAPM plus two factors

WI the goal of FF3F? • The purpose of the FF3F is to explain average returns

• Aim of today's lecture:
• See the 3F model of FF(1996) in action
• Read carefully one paper Multifactor Explanations by FF96
○ Possibly the most famous paper in Finance in the past 30 years
WD FF3F paper do to • The paper lays out and uses the most common and current model used in practice
explain average
returns? ○ It explains how asset managers strive to get returns

Fama & French (1996): Multifactor Explanations
• Background:
WI the first factor? • The CAPM model is the starting point of asset pricing models.
○ Its specification is:
▪
○ Risk-return relation: expected returns should be proportional to Beta
WI the expectation of
risk-return relation?




○ The betas come from time-series regression
WI the specification
to get the betas and ▪ Specification of time-series regression:
factor in CAPM?

• Fama and French (1996) come up with 25 portfolios and calculate the expected
HD FF96 calculate returns.
expected returns?
○ They contrast the average returns of the portfolios proportional to Beta
○ Betas come from time-series regression
▪ They find that the relationship between risk and returns would not be
positive as expected.
○ They aim to explain how do the models work.

WD they find out? • They expect the beta regression line to be an upward slope, but in reality it would be a
negative slope
WI the implication of • The paradox is that more risk is not being rewarded by more return
this finding? • This leads to an empirical rejection of the CAPM

WD they propose as an • They propose using 2 additional factors to complete the CAPM and explain residual asset
alternative model to returns.
investigate sources of □ The sensitivity of returns to three factors:
returns?
○ RMRF (market factor): excess returns on a broad market portfolio.
WI the market factor? ○ HML (value factor): the difference between the return on a portfolio of high-
WI the value factor?
book-to-market stocks and the return on a portfolio of low-book-to-market
stocks.



IIM Page 4

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