Investment Management: Challenges, Alternatives, and Opportunities

Developing a Profitable ETF Business

QUESTION 1

A leading fund management company has just announced the purchase of an Exchange Traded

Fund (ETF) platform. The platform provides management services to ETFs and also offers

access to investors to a wide range of ETFs globally. The fund management company

announces that the acquisition will be used to support the growth of smart beta strategies.

(a) Describe the challenges in developing a profitable ETF business.

(b) Identify three issues for an investor to consider when deciding whether to invest in an ETF holding physical assets or one which only uses derivatives to gain market exposure.

(c) Explain what in-kind creation and in-kind redemption for ETFs refers to.

(d) Explain the term ‘smart beta’ and why fund management firms are looking to expand their range of smart beta strategies.

(e) Identify two challenges for a fund management company to grow through acquisition of other fund management firms.

QUESTION 2

You are an investment advisor and have been asked by a client to investigate the attraction of investing in alternatives.

(a) Suggest an alternative type of collective scheme which would give the investor exposure to property and discuss the advantages and disadvantages of this type of scheme compared to an open-ended property fund.

(b) Identify the three major sectors of the commercial property market.

(c) Briefly explain three main exit routes for private equity investors in a company.

(d) If the client wants their investments to provide protection against inflation identify one other alternative asset class (not property) which might provide protection against inflation risk and explain why the returns from the asset are linked to inflation.

(e) There are five different financing stages in venture capital: seed, early stage, mid/late stage, lists and going to private again. Please fill in the table below. Seed Early stage Mid/late stage Lists Private again Who funds Major risk for company Parties whom investor deal with Likely to be cash generating?

QUESTION 3

(a) You are an institutional investment manager and have been appointed to run a £100 million portfolio which will be invested across global markets. Please answer question 1 to 3

(1) Explain how you will use an optimisation model to assist in the allocation of the portfolio across different markets.

(2) You have agreed with the client the strategic asset allocation and are now discussing tactical asset allocation. Briefly explain the purpose of tactical asset allocation.

(3) Discuss whether strategic or tactical asset allocation is most important in determining the client’s investment performance.

(b) There are five business cycles, including initial recovery, early expansion, late expansion, slow down, and contraction. Please explain how each of this cycle influence the yield curve.

QUESTION 4

You are looking at the opportunities for participants in the investment management industry.

(a) Identify the major types of clients in the main investment management markets.

(b) Explain two advantages of being a manager of open-end funds and two advantages of being a manager of closed-end funds.

(c) Explain four key characteristics of private equity investment from the investor viewpoint.

(d) If the client decides to invest in private equity through a fund, identify the fees that are likely to be charged by the manager of the fund.

(e) Explain two advantages of being a manager of active funds and two advantages of being a manager of passive funds.

QUESTION 5

You are provided with the following information on a UK equity market neutral fund which is targeting absolute returns of at least 6% per annum for its investors. Performance numbers are based on the past three years’ performance.

(a) Is an equity market neutral strategy a directional or a non-directional strategy? Explain your answer with reference to how a manager might look to generate investment returns using an equity market neutral strategy.

(b) Calculate the net exposure of the fund and comment on the exposure in light of the strategy of the Fund.

(c) If the risk-free rate over the last 3 years has averaged 0.5% per annum, calculate the Sharpe ratio of the Fund.

(d) Why might an investor wish to know the Sortino ratio for the Fund? Explain why the Sharpe ratio and the Sortino ratio are different for this Fund.

(e) Use the Fundamental Law of Active Management to discuss whether you expect an equity market neutral fund to achieve higher or lower risk-adjusted returns than a long-only equity fund.