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Home > Asset Management Best Practice

Asset Management Best Practice

Best Practice

Internationally renowned finance leaders, experts and educators distil and summarize the most important aspects of finance best practice. Each Best Practice essay has an Executive Summary for quick reference, outlining the main points. The Making It Happen feature illustrates practical applications, and where relevant authors have provided illustrative case studies and definitions.

  • A Practitioner’s Perspective on Investment Management for Shareholder Funds of European Insurers
    by Kambiz Deljouie, Corrado Pistarino
    The leveraged insurer’s balance sheet is the key structural element to consider when designing an investment framework for managing shareholders’ funds. Capital is a scarce (and costly) resource to replenish. With the exception of unit-linked products, all other books of business contain payment obligations, which are ultimately guaranteed by the company’s shareholders and are met by the performance of the investment portfolios. To ensure that...
  • Asset Allocation Methodologies
    by Tom Coyne
    Everyone has financial goals they want to achieve, whether it is accumulating a target amount of money before retirement, ensuring that a pension fund can provide promised incomes to retirees, or, in a different context, achieving an increase in corporate cash flow. Inevitably, we do not have unlimited resources available to achieve these goals. We often face not only financial constraints, but also shortages of information, time, and cognitive...
  • Booms, Busts, and How to Navigate Troubled Waters
    by Joachim Klement
    For many, the tech bubble of the late 1990s is probably the most prominent example of a stock market boom and bust. Figure 1 shows the exuberance in the Nasdaq Composite stock market index, which includes a significant proportion of technology and telecommunications stocks, compared to the S&P500 Index of the 500 large-cap stocks from traditional sectors like industrials, transportation, utilities, and financials. As the internet and information...
  • Carrying Out Due Diligence on Hedge Funds
    by Amarendra Swarup
    Hedge funds have often been cited as valuable additions to any institutional portfolio, thanks to their typically uncorrelated returns to traditional asset classes over the long term, and superior risk-adjusted returns. However, they are also a complex and volatile asset class, and since their ascent onto the investment podium, both institutional and private investors have found themselves burned at regular intervals by embarrassing and costly...
  • Carrying Out Due Diligence on Private Equity Funds
    by Rainer Ender
    The term “due diligence” covers a broad range of different due diligence types. These can be grouped into three major types; financial, legal/tax, and business due diligence. The goal of this article is to shed light on business due diligence for investing in private equity funds. Due diligence is commonly defined as “the process of investigation and evaluation, performed by investors, into the details of a potential investment, such as an...
  • Corporate Covenant and Other Embedded Options in Pension Funds
    by Theo Kocken
    Pension funds in their defined benefit (DB) form and the alternative structures that have evolved over time are among the most complex risk-sharing institutions ever created, not least because they involve many stakeholders (such as employers, retirees, and employees), all of whom assume different risks.The employers assume some of the risks by, for example, being obligated to replenish any shortfall in the pension fund. The pensioners and...
  • ERM, Best’s Ratings, and the Financial Crisis
    by Gene C. Lai
    The recent financial crisis has raised some questions, such as why enterprise risk management (ERM) was not able to prevent some large insurance companies from either becoming insolvent (for example, AIG) or from suffering large losses of their market value (for example, Lincoln National), and whether rating agencies properly perform their jobs.1 It is critical that insurance companies have effective ERM programs, and that rating agencies...
  • Ethical Funds and Socially Responsible Investment: An Overview
    by Chendi Zhang
    Ethical funds, often also called socially responsible investment (SRI) funds, integrate environmental, social, and governance (ESG) considerations, or purely ethical issues, into investment decision-making. SRI has experienced a phenomenal growth around the world. According to the Social Investment Forum, the professionally managed assets of SRI portfolios in the United States, including retail and, more importantly, institutional funds (for...
  • Forecasting Default Rates and the Credit Cycle
    by Martin S. Fridson
    Cycles play a major role in analysis aimed at achieving superior investment returns. Stock market participants base their valuations on corporate earnings, which fluctuate with the business cycle. The interest rate cycle strongly influences the performance of high-quality fixed-income assets, such as government bonds and mortgage-backed securities. Similarly, investors in corporate bonds, for which the risk of default is a material factor, can...
  • Funds of Hedge Funds versus Single-Manager Funds
    by Steve Wallace
    Funds of hedge funds (FoHFs) have caused heated debate over the years no matter which side of the fence you are on. The main issue this debate revolves around has two parts:Fees—that is, fees charged at the underlying manager level and then again at the FoHF level.Control: Accepting that you don’t have the internal expertise and must pass control of the underlying fund selection to a FoHF manager can be difficult for some. They would rather have...
  • Hedge Fund Challenges Extend Beyond Regulation
    by Kevin Burrows
    Victim Rather than VillainThe hedge fund sector has been vilified by some politicians, both in Europe and in the US, as if it were a significant contributor to the banking collapse and subsequent global recession. In reality, the hedge fund industry was very much a victim of the banks during the latter half of 2008, and there are some significant litigation actions pending, in which hedge funds are suing investment banks for alleged misdealings...
  • How Stockholders Can Effectively Engage with Companies
    by James Gifford
    How many social workers does it take to change a light bulb? One. But the bulb has got to want to change. This is also the theme of this essay on stockholder engagement—the practice of investors seeking to influence corporate behavior for the better.Institutional investors are increasingly engaging in dialog with companies for the purpose of improving some aspect of a company’s environmental or social impact, corporate governance, or strategic...
  • Investing Cash: Back to Basics
    by Mark Camp, Emma Du Haney
    It has become crystal clear that cash must be treated as a separate asset class. This means taking care when considering how, and with whom, cash should be held and invested.It is equally clear that risk is a very relevant factor for cash. Institutional investors have discovered in the past year that so-called safe cash investments have not been as secure as they thought. For many years, investors have ignored the fundamental principle that...
  • Investing in Structured Finance Products in the Debt Money Markets
    by Moorad Choudhry
    The application of synthetic securitization and structured finance techniques in debt capital markets has made a range of asset classes available to investors who would not otherwise have access to them. Thus banks, fund managers, and cash-rich corporate institutions can choose from a wide variety of investment options for their funds. This article introduces a sample of money market products that present alternatives for the investment of...
  • Managing Shariah-Compliant Portfolios: The Challenges, the Process, and the Opportunities
    by John Sandwick
    It is still puzzling to understand why something as straightforward as Islamic wealth and asset management has eluded the professional classes to date. At the time of writing, only one single major global money center bank, and paltry few independent asset managers, had constructed credible service offerings for Muslim clients who wish to enjoy shariah-compliant investing along with professional investment management.1This seems counterintuitive...
  • Measuring Company Exposure to Country Risk
    by Aswath Damodaran
    If we accept the proposition of country risk, the next question that we have to address relates to the exposure of individual companies to country risk. Should all companies in a country with substantial country risk be equally exposed to country risk? While intuition suggests that they should not, we will begin by looking at standard approaches that assume that they are. We will follow up by scaling country risk exposure to established risk...
  • Measuring Country Risk
    by Aswath Damodaran
    Two key questions must be addressed when investing in emerging markets in Asia, Latin America, and Eastern Europe. The first relates to whether we should impose an additional risk premium when valuing equities in these markets. As we will see, the answer will depend upon whether we view markets to be open or segmented and whether we believe the risk can be diversified away. The second question relates to estimating an equity risk premium for...
  • Money Managers
    by David Pitt-Watson
    Money managers (also known as fund managers or investment managers) manage money on behalf of other people. In most Western countries more than half the population will, directly or indirectly, have a money manager working for them. The managers find suitable investments, and are usually given the discretion by clients to make investments on their behalf.It is usually the client who owns the investment and takes the risk that it will do well or...
  • Passive Portfolio Management and Fixed-Income Investing
    by Andrew Ainsworth
    An allocation of investment to fixed-income assets is an important component of any diversified investment strategy. The fixed-income asset class comprises a variety of debt instruments that include government bonds, corporate bonds, municipal bonds, mortgage-backed securities, inflation-indexed debt, and convertible bonds, among others. With such a large number of securities available from which to construct a portfolio, this article reviews...
  • Private Equity Fund Monitoring and Risk Management
    by Rainer Ender
    Private equity fund commitments tend to be long-term investments of approximately 12 years. The fund’s life consists of three general phases:Investment phase: deal origination, due diligence, investments; Value creation phase: (re-)positioning the investments for success; Harvesting phase: divesting portfolio companies. Private equity monitoring is a continuous process of tracking the fund’s progress and the fund manager’s development. The goal...
  • Risk Management Revisited
    by Duncan Hughes
    Risk management has taken centre stage in many commercial organizations in recent years, but it is in the financial services industry that it has assumed the greatest prominence, particularly since the subprime crisis and the ensuing credit crunch of the late “noughties.” Major banks and asset management firms now boast a chief risk officer (CRO) sitting alongside the chief financial officer (CFO) and other executives on the main board. While...
  • Sukuk Issuance and Issues in Purchase Undertakings
    by Barry Cosgrave
    As is the case with most Islamic finance instruments, the typical approach to sukuk is to take the equivalent instrument in conventional finance and to attempt to replicate it in a way that is shariah-compliant. In the case of sukuk, consideration is given to the important commercial features (such as rate of periodic return, return at maturity, and financial covenants), together with key legal considerations (such as transaction risk...
  • The Ability of Ratings to Predict the Performance of Exchange-Traded Funds
    by Gerasimos G. Rompotis
    Exchange-traded funds, or ETFs, are a relatively new investment product, but they are very important for both institutional and retail investors. ETFs are hybrids of ordinary corporate stocks and open-ended mutual funds which invest in baskets of shares that closely replicate the performance and risk levels of specific broad sector and international indexes. As such, ETFs offer investors a considerable level of risk diversification with just a...
  • The Case for SMART Rebalancing
    by Arun Muralidhar, Sanjay Muralidhar
    Every fund manager has to deal with a vexing issue—namely, how to manage the rebalancing process as the returns from this activity impact the total portfolio performance. There is a wealth of information on these strategies, and many papers have been written on this topic.1 Nersesian (2006) does an excellent job of introducing a process to help determine the ideal rebalancing policy and examine the considerations in selecting the appropriate...
  • The Changing Role and Regulation of Equity Research
    by Simon Taylor
    Equity research is the publication by analysts of reports, notes, and emails that offer an investment recommendation on the quoted stock of a company (typically buy, sell, or hold). The recommendation is supported by an investment case, financial forecasts, and a valuation. Reports vary enormously, from short updates of a page or less to substantial documents that analyze whole industries and companies in great detail.Equity research is also...
  • The Impact of Index Trackers on Shareholders and Stock Volatility
    by Martin Gold
    Stock indexing, where investment portfolios mimic or replicate market indexes, has profound implications for both firms and investors. The practice stems from theoretical research which suggests that markets are informationally efficient. Since security prices generally reflect all public information, there is no point in employing active fund management and paying for investment research if there is no prospect of reliably beating the market....
  • The Performance of Socially Responsible Mutual Funds
    by Luc Renneboog
    Over the past decade, socially responsible investment (SRI), frequently also called ethical investment or sustainable investment, has grown rapidly around the world. SRI is a process that integrates social, environmental, and ethical considerations into investment decision making. Unlike conventional types of investment, SRI funds apply a set of investment screens to select or exclude assets based on ecological, social, corporate governance, or...
  • The Role of Commodities in an Institutional Portfolio
    by Keith Black, Satya Kumar
    The case for commodities is based largely on their historical tendency to offer returns that exhibit a low correlation with those of stock and bond market indices. Although commodities may be volatile, their low correlation with traditional investments can result in a significant diversification benefit. Table 1 shows the correlation between two commodity indices—the Standard & Poor’s GSCI (S&P GSCI) and the Dow Jones–AIG Commodity Index...
  • The Role of Short Sellers in the Marketplace
    by Raj Gupta
    The term “short-selling” or “shorting” is used to describe the process of selling financial instruments (such as equities or futures) that the seller or holder does not actually own but borrows from various sources. If the value of the instrument declines, the short-seller can repurchase the instrument at a lower price and cover the loan. Short-sellers have long played the crucial role of price discovery in financial markets. If short-selling...
  • Understanding the Role of Diversification
    by Guofu Zhou
    To diversify is to do things with variety in order to improve well-being. Diversification is thus a common and fundamental concept in both daily life and business. However, the practice is primarily known as a way of reducing risk by investing in a variety of assets or business ventures. Buying one utility stock in the East coast and one in the West will minimize local shocks, while maintaining roughly the same return as buying either of the two...
  • Valuation and Project Selection When the Market and Face Value of Dividends Differ
    by Graham Partington
    Suppose that a company declares a cash dividend of $1, then the face value of the dividend is $1. The market value, which is what that dividend trades for in the market, may, or may not, be the same as the face value. Traditional approaches to valuation, such as the discounted dividend model (see “Using Dividend Discount Models”), usually assume that the market value and the face value of dividends are the same. When this is not the case you hit...
  • Venture Capital Funds as an Alternative Class of Investment
    by Michael D. McKenzie, Bill Janeway
    The modern venture capital industry began after the Second World War, when the first venture funds were created to commercialize technology that had been developed during the war.1 A formal trade association was created in 1974 with the formation in the United States of the National Venture Capital Association (NVCA). However, venture capital was still a relatively small and esoteric investment sector, with fewer than 100 firms and less than...
  • WACC versus APV Valuation: Financial Policy and the Discount Rate
    by Antoine Hyafil
    Franco Modigliani and Merton Miller’s (1958) Propositions I and II have generated two valuation methodologies, hereafter referred to as WACC (weighted average cost of capital) and APV (adjusted present value) valuation. Briefly, Proposition I states that the value of a firm does not depend on its capital structure, and Proposition II states that a firm’s value depends on three things: the required rate of return on its assets; its cost of debt;...
  • When Form Follows Function: How Core–Satellite Investing Has Sparked an Era of Convergence
    by Christopher Holt
    “It is the pervading law of all things organic and inorganic…that form ever follows function.”Nineteenth century Chicago architect Louis Sullivan famously observed that a building’s design must follow from its functional use. The same might be said about the design of modern portfolios and their management entities (pensions, endowments, asset managers, etc.). After emerging over the past decade as a simple portfolio management rubric,...

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