Enhanced indexing in bonds attempts to match the index by covering transaction and management costs while controlling risk. Enhanced indexing in stocks tries to outperform the benchmark index while controlling risk. Is this correct??
i don’t think it will ourperform the benchmark index b/c of mngt & transaction fees… only when you mismatch primary risk factors (duration) will it start to perform the same as the index…
the goal is to outperform the index enough before costs and mgmt fees so that after those are taken into consideration you don’t trail the index…
Enhanced Indexing in Stocks: over/underweighting specific securities in the benchmark so as to generate alpha. Enhanced Indexing in Bonds can take one of the following forms: minor or major risk factor mismatches; or you could match primary risk factors. And I think in each of these duration is unchanged compared to the benchmark, correct?
Nope, i believe major risk factor mismatch allows for changing duration.
Enhanced = underperform Enhanced w/minor tilts = outperform That how I understood it
I didn’t think duration was changed unless you had full blown active management. Is tanyusha risht?
jimmylegs Wrote: ------------------------------------------------------- > I didn’t think duration was changed unless you had > full blown active management. Is tanyusha risht? if duration changed it is full blown active management
CSK - I agree. Also, I believe duration is unchanged with major risk mismatches. ANyone else?
Guys, are you sure? I have it under Active Management by Larger Risk Factor Mismatches: might alter duration of portfolio or individual sectors.
Maybe it can alter duration of individual sectors but the overall duration remains unchanged???
Ok, i googled it and got a link to Fabozzi book: “Active Management/ Larger Risk Factor Mismatches The manager will make larger mismatches in the risk factors to attempt to add greater value. This approach may also make small duration bets.” http://books.google.com/books?id=mnnfw9muEzAC&pg=PA41&lpg=PA41&dq=active+management+by+larger+risk+factor+mismatches+duration+changes&source=web&ots=38hIGmyorD&sig=6dCI_Wqm0XpO7AnVJkUikhROE1Y&hl=en#PPA41,M1
jimmylegs Wrote: ------------------------------------------------------- > CSK - > > I agree. Also, I believe duration is unchanged > with major risk mismatches. ANyone else? take sample exam #1 or #2 (dont remember which one) and you will find out
tanyusha Wrote: ------------------------------------------------------- > Ok, i googled it and got a link to Fabozzi book: > “Active Management/ Larger Risk Factor Mismatches > The manager will make larger mismatches in the > risk factors to attempt to add greater value. > This approach may also make small duration bets.” > > http://books.google.com/books?id=mnnfw9muEzAC&pg=P > A41&lpg=PA41&dq=active+management+by+larger+risk+f > actor+mismatches+duration+changes&source=web&ots=3 > 8hIGmyorD&sig=6dCI_Wqm0XpO7AnVJkUikhROE1Y&hl=en#PP > A41,M1 what is considered small?
Here’s Schweser’s Notes: Enhanced Indexing by Matching Primary Risk Factors Due to the number of issues in the typical bond index as well as the inefficiencies and costs associated with pure bond indexing, that strategy is rarely implemented. Instead, managers will enhance the portfolio return by utilizing a sampling approach to replicate the index’s primary risk factors while holding only a percentage of the bonds in the index. Sampling reduces the costs associated with constructing the portfolio, and matching the risk factors means the portfolio is exposed to the same risk factors as the index. This means the portfolio will track the index closely, and since lower transactions costs are incurred, this strategy will outperform a pure bond indexing strategy. Enhanced Indexing By Small Risk Factor Mismatches This is the first level of indexing that is designed to earn about the same return as the index. While maintaining the exposure to large risk factors, such as duration, the manager slightly tilts the portfolio towards other, smaller risk factors by pursuing relative value strategies (e.g., identifying undervalued sectors) or identifying other return-enhancing opportunities. The small tilts are only intended to compensate for administrative costs. Active Management By Larger Risk Factor Mismatches The only difference between this strategy and enhanced indexing by small risk factor mismatches (the preceding strategy) is the degree of the mismatches. In other words, the manager pursues more significant quality and value strategies (e.g., overweight quality sectors expected to outperform, identify undervalued securities). In addition, the manager might alter the duration of the portfolio somewhat. The intent is earning sufficient return to cover administrative as well as increased transactions costs without increasing the portfolio’s risk exposure beyond an acceptable level. So I stand corrected… it looks like duration can be tilted. Although I do recall in Secret Sauce that they say large mismatches do not change the duration. Schweser seems to be inconsistent.
I confirmed in CFAI text, V3, p320: “The manager may … adjust the portfolio’s duration slightly away from benchmark index’s duration to take advantage of perceived opportunity” is one of the examples of larger risk factor mismatches.