Investment Management Certificate (IMC) Portfolio Management, Construction and Performance Syllabus

State two main arguments in favour of passive management.

Lower costs (management fees and transaction costs) and the difficulty of consistently beating the market after fees (consistent with market efficiency), so most active managers underperform their benchmarks net of costs over the long run.

Define alpha in the context of active management.

Alpha is the excess return of a portfolio relative to the return predicted by its benchmark/market exposure (beta) — the value added (or subtracted) by the manager's active decisions after adjusting for systematic risk.

What is the difference between full replication and sampling in index tracking?

Full replication holds every constituent of the index in its index weight; sampling (optimisation/stratified) holds a representative subset chosen to mimic the index's risk and return characteristics, used when full replication is costly or impractical for large or illiquid indices.

Contrast value and growth equity investment styles.

Value investing targets stocks trading cheaply relative to fundamentals (low P/E, low P/B, high dividend yield) on the view they are underpriced. Growth investing targets companies with above-average earnings/revenue growth, accepting higher valuation multiples in expectation of continued expansion.

What characterises the income (yield) equity investment style?

A focus on shares paying high, sustainable dividends to generate a reliable income stream, often favouring mature, cash-generative companies, typically appealing to investors prioritising current income over capital growth.

Distinguish top-down from bottom-up equity investment approaches.

Top-down starts with macroeconomic and market analysis to choose countries, sectors and asset classes, then selects securities within them. Bottom-up focuses first on individual company analysis and fundamentals, building the portfolio from attractive stocks regardless of broad macro views.

What is meant by an equity portfolio's market-capitalisation style (e.g. large-cap vs small-cap)?

It classifies portfolios by the size of companies held: large-cap funds hold big, established firms (typically lower risk, more liquid), while small-cap funds hold smaller companies offering higher growth potential but greater risk and lower liquidity.

Name three common active fixed income strategies.

Duration positioning (adjusting interest-rate sensitivity relative to benchmark), yield curve positioning (e.g. bullet, barbell, or riding the curve), and credit/sector selection (spread trades, choosing issuers or credit qualities to add return).

Contrast a bullet and a barbell bond strategy.

A bullet concentrates maturities around a single point on the yield curve. A barbell combines short and long maturities with little in the middle. They have similar durations but different convexity and respond differently to yield-curve shape changes.

What is bond immunisation?

A passive fixed income strategy that structures a portfolio so its duration matches an investor's investment horizon (or liabilities), locking in a target return by offsetting price risk and reinvestment risk against interest-rate changes.

What is meant by "riding the yield curve" (rolldown)?

Buying a bond with a longer maturity than the holding period so that, on an upward-sloping yield curve, the bond's yield falls (and price rises) as it ages toward shorter maturities, generating extra return beyond the initial yield.

Define smart beta.

Rules-based, transparent investment strategies that weight a portfolio by factors other than market capitalisation (e.g. value, size, momentum, quality, low volatility, equal weight) to capture systematic factor premia, typically at lower cost than traditional active management.

What are the commonly cited equity risk factors in factor investing?

Value, Size (small minus big), Momentum, Quality (profitability), Low Volatility/Minimum Volatility, and the broad Market factor — each representing a systematic source of return that can be targeted.

How does factor investing relate to traditional active and passive management?

It sits between the two: like passive, it is rules-based, transparent and low-cost; like active, it deliberately deviates from cap-weighted benchmarks to capture excess returns from documented risk premia, sometimes described as harvesting alpha systematically as cheap beta.

State the formula for the holding period return (HPR) of an investment.

$$HPR = \frac{P_{1} - P_{0} + D_{1}}{P_{0}}$$ where $P_{0}$ is the starting price, $P_{1}$ the ending price and $D_{1}$ the income received during the period.

What is the difference between the money-weighted rate of return (MWRR) and the time-weighted rate of return (TWRR)?

MWRR is the internal rate of return that accounts for the size and timing of cash flows (sensitive to investor contributions/withdrawals). TWRR removes the effect of cash-flow timing by compounding sub-period returns, giving a fairer measure of the manager's performance.

Why is the time-weighted return preferred for evaluating an investment manager?

Because the manager generally does not control the timing or size of client cash flows; TWRR strips out this distortion so the return reflects only the manager's investment decisions, making it suitable for comparison against benchmarks and peers.

How is the time-weighted return calculated when there are interim cash flows?

Compute the sub-period return between each cash flow and chain-link (geometrically compound) them: $$TWRR = \left[(1+r_{1})(1+r_{2})\cdots(1+r_{n})\right] - 1$$ where each $r_i$ is the return over a sub-period between cash flows.

State and interpret the Sharpe ratio.

$$S = \frac{R_{p} - R_{f}}{\sigma_{p}}$$ It measures excess return per unit of total risk (standard deviation). A higher Sharpe ratio indicates better risk-adjusted performance; it is useful for ranking portfolios held as an investor's total wealth.

State and interpret the Treynor ratio.

$$T = \frac{R_{p} - R_{f}}{\beta_{p}}$$ It measures excess return per unit of systematic (market) risk, beta. It is appropriate when the portfolio is one of several well-diversified holdings, since only systematic risk is rewarded.

Define Jensen's alpha and give its formula.

Jensen's alpha is the portfolio return in excess of that predicted by the CAPM: $$\alpha_{p} = R_{p} - \left[R_{f} + \beta_{p}(R_{m} - R_{f})\right]$$ A positive alpha indicates outperformance relative to the risk taken.

What does the information ratio measure, and how is it calculated?

It measures active return per unit of active risk: $$IR = \frac{R_{p} - R_{b}}{\sigma_{(R_{p}-R_{b})}}$$ i.e. excess return over the benchmark divided by the tracking error. It gauges the consistency and efficiency of a manager's active skill.

When is the Sharpe ratio more appropriate than the Treynor ratio, and vice versa?

Use the Sharpe ratio when the portfolio represents the investor's entire wealth (total risk matters). Use the Treynor ratio when the portfolio is one component of a larger diversified portfolio, so only systematic risk (beta) is relevant.

What is performance attribution?

The analysis that decomposes a portfolio's return relative to its benchmark into the contributions from specific active decisions, typically asset allocation, security/stock selection and their interaction, to explain the sources of out- or underperformance.

In Brinson-style attribution, what do the asset allocation and selection effects measure?

The allocation effect captures value added by over/under-weighting sectors or asset classes versus the benchmark; the selection effect captures value added by choosing securities that outperform within each sector/class. An interaction term captures the combined effect.

What is the formula for the allocation effect in Brinson attribution for a segment?

$$\text{Allocation} = (w_{p} - w_{b}) \times (R_{b} - R_{b,total})$$ where $w_{p}$ and $w_{b}$ are the portfolio and benchmark weights in the segment and $R_{b}$ is the benchmark return of that segment relative to the total benchmark return.

What is the purpose of the GIPS (Global Investment Performance Standards)?

GIPS are voluntary, globally recognised ethical standards (maintained by CFA Institute) for calculating and presenting investment performance, ensuring fair representation and full disclosure so that prospective clients can compare firms on a consistent and credible basis.

What is a key GIPS requirement regarding composites?

Firms must group all actual fee-paying discretionary portfolios with similar mandates/strategies into composites and present composite (not selectively chosen) returns, preventing cherry-picking of only the best-performing accounts.

Define ESG integration in investment management.

The systematic and explicit inclusion of material environmental, social and governance factors into traditional financial analysis and investment decision-making, aiming to better assess risk and identify opportunities and improve long-term risk-adjusted returns.

Distinguish negative screening, positive/best-in-class screening, and thematic investing as responsible investment approaches.

Negative screening excludes companies/sectors that fail ethical or ESG criteria (e.g. tobacco, weapons). Positive/best-in-class screening selects firms with superior ESG performance within a sector. Thematic investing targets specific sustainability themes (e.g. clean energy, water). A further approach, impact investing, seeks measurable social/environmental impact alongside financial return.

What is stewardship (active ownership) as a responsible investment approach, and what UK code governs it?

Stewardship is the use of engagement and voting rights by investors to influence company behaviour on ESG and long-term value matters. In the UK it is governed by the FRC's UK Stewardship Code, and globally investors may be signatories to the UN Principles for Responsible Investment (PRI).