GLOBAL INVESTMENT

STRATEGIST
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HOUSEKEEPING ITEMS
Introductions
Syllabus
House keeping items (grading, forming groups, assign topics for
paper)
Objectives of the class
Questions?
 Contact me at pyepez@chicagobooth.edu

Q&A sessions from 8:00AM to 8:10AM

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 DAY 1 - THE
FINANCIAL SYSTEM
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DAY 1 - THE FINANCIAL
SYSTEM

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DAY 1 - THE FINANCIAL
SYSTEM

76,291 2020)

11% 50% 39%

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EQUITIES

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EQUITIES
Represent ownership share in a company
Residual claim(after debt has been paid)
Issued by corporations
Limited liability
Types:
 Common: receives dividend only after claims have been paid. Lowest priority in
liquidation
 Preferred: hybrid bond and stock, gets pay a dividend

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VALUATION
Most direct use of valuation is to guide value of stock
Reading the market – prices include expectations
Quantitative (earnings [quality], margins, sales) and qualitative
(firm’s management, transparency) factors
Premium for control and discounts for lack of marketability or
liquidity

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EQUITY MARKETS
Stock exchanges – private bourses, public bourses, order-driven
(Paris or Tokyo) and price-driven (Nasdaq)
Taxes involved: capital gains and income tax
Cost: commission, market impact, opportunity cost
ADRs: over the counter, registered and Pos

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RETURNS
Holding period return= P1-P0+CF1 = P1+CF1-1
Po Po
CF1/Po= cash yield P1-Po/Po= price appreciation
Equity risk premium=required return-risk free

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RISK PREMIUM
Estimates for risk premium:
 Historical
 Forward looking: Gordon Model (D1/P)+g-r(free)
 Macro models: premium=(1+inf)(1+rgGDP)(1+rg p/e)-1+Yield-Rfree
 Surveys

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CAPM
Capital Asset Pricing Model (CAPM)
 Req return of j=rfree+(equity risk premium)(beta of j)

Multifactor model: req return=Rfree+risk premium1+risk

premium2+….
Fama-French: multifactor model
 Req return ofj=RF+Bj(returnmkt-Rfree)+Bsb(Rs-Rb)+Bhl(Rh-Rl)
 Market premium, Small cap premium and value premium

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BETA
Regress the returns of company’s stock on return of overall market (5
years)
Beta drift: adjusted beta=2/3b+1/3(1)

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WACC
Cost of Capital
 Mv debt * rd(1-tax)+Mv eq *re
Mvdebt.eq Mvdebt.eq

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EQUITY ANALYSIS

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EQUITY ANALYSIS
Issues when investing globally
 Information problem: delayed or infrequent financial statements
 Language
 Inconsistent
 GAAP (Generally accepted accounting principles) and IFRS (International Financial
Reporting Standards)
 Business cycle synchronization

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EQUITY ANALYSIS
DuPont model: used to analyze past performance
ROE=NI/Eq=
Ni/EBT*EBT/EBIT*EBIT/sales*sales/assets*assets/Equity

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DISCOUNTED DIVIDEND
VALUATION
Stock valuation cash flows:
 dividends (policies, stability)
 free cash flows (positive, negative correspond to profitability)
 residual income (amount of earnings in excess of investor’s required return)

DDM: Vo=D1+P1 (one period

1+r

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DISCOUNTED DIVIDEND
VALUATION
DDM: Vo= D1_+ D2+P2 (2 periods
(1+r)1 (1+r)2

DDM: SUM Dt____

t
(1+r)

Gordon Growth Model

 Vo=D1/(r-g)

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PRICE TO EARNINGS
RATIO
P/E or price to earning, most commonly used relative value indicator
 Leading P/E=Po/E1=D1/E1
r-g
 Trailing P/E=Po/Eo=Do*(1+g)/Eo
r-g

Expected r implied by DDMs

 R=D1/Po +g

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FREE CASH FLOWS
VALUATION
Firm value=FCFF discounted at WACC
 FCFF=NI+NCC+[Int*(1-tax%)]-FCInv-WCInv

Equity Value=FCFE discounted at req r eq

 FCFE=FCFF-[Int*(1-Tax%)]+net borrowing

Value of Firm=FCFFo*(1+g)
WACC-g

WACC=we*re+[wd*rd*(1-Tax%)

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MARKET-BASED
MULTIPLES
P/E: fundamental vs. observed
P/B: usually positive, more stable, liquid assets, no outsourcing
P/S: always positive, sales not easy to manipulate, high sales not
equal to high profit
P/CF: hard to manipulate, more stable, non-cash revenue

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FIXED INCOME

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BONDS
Government
 Bills, Notes, Bonds, TIPS

Corp
 Investment grade
 High Yield

Agencies
MBS
Emerging Markets
Munis: tax-backed or revenue bonds

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RATINGS
Rating agencies:
 S&P
 Moody's
 Fitch

They review:
 quality of collateral
 Legal structure
 Covenants

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CREDIT ANALYSIS
Four Cs: Character, Covenants, Collateral, capacity
Ratios:
 ROE=Net Income/Equity
 Current Ratio=Current assets/current liabilities
 Acid-test= (CA-inventories)/CL
 Capitalization:
 L-t debt to cap ratio=l-t debt/(l-t debt+equity+preferred)

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YIELD CURVES

You can use bills, notes, bonds,

strips,

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DURATION
Sensitivity of the value of the security to changes in interest rates.
Approximate change percentage in the value of a bond in response to
a 100 basis points change in corresponding interest rate

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SPREADS
Nominal spread: bonds’ yield to maturity-yield on comparable
maturity treasury benchmark
Option Adjusted Spread: spread of bond with embedded options
after value of option has been removed (callable,,putable,
convertible bonds)

Spread=Credit risk+liquidity risk+option risk

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GOVERNMENT BONDS
T Bills (1, 3, 6 months)
Notes (1-10 years)
Bonds (10-30 years)
TIPS: Inflation linked

Agency Bonds

Quasi government bonds issued by FNMA or Freddie Mac

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CORPORATE BONDS
Investment Grade
High Yield
Notes

International Bonds
Emerging Markets Issued by Emerging market countries

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 MORTGAGE-BACKED
SECURITIES
Pool or mortgages
Mortgage payment is composed of principal (which increases as time passes),
interest (which decreases as time passes) and servicing fee (which declines as
time passes)

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 MORTGAGE-BACKED
SECURITIES
Pass-through security is a claim against a pool of mortgages
Main issuers are: Ginnie Mae, Freddie Mac, Fannie Mae
CPR: rate at which mortgage pool balance is assumed to be prepaid
during life of pool
Prepayments: interest rate, housing turnover, characteristics underlying
mortgages
Prepayment riks: Contraction or Extension

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CMOS
CMOs: security issued against pass-through securities
Separated in tranches

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COMMERCIAL CMBS
Backed by income producing real estate
Analysis of CMBS focuses on the credit risk of the properties

Asset backed Securities (ABS)

Auto loans or Credit cards or Student Loans, CDOs

Seller (Ford), Issuer (Trust), Servicer (Ford)
Can have external credit enhcements such as corporate guarantees,
letters of credit, bond insurance

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DERIVATIVES

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FORWARDS
Buyer (long forward) agrees to buy an asset in the future from the
Seller (short forward position)
Each party exposed to default risk
FP=So(1+Rfree)T
No arbitrage at begiing or To
Vo (of long position)=So-[FP/(1+Rfree) T]
Value at To=zero, Tt=+-, Tex=St-FP

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FUTURES
Similar to Forwards: contract obligates the long to buy and short to
sell an asset at a specific price on a specified date; cash settlement;
priced to have zero value at To
Important differences are: futures are mark to market (or priced
daily); forwards are private contracts while Futures are contracts
trade in exchanges; Forwards are customized while Futures are
standard; Forwards have couters party while Futures have a clearing
house; Forward are not related while Futures are

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FUTURES
Each exchange has a clearing house. The clearing house guarantees
that traders in the Futures market will honor their obligations
Future contract has no value at To
Future contracts don’t accumulate value overtime
 FP=So*(1+Rfree)T

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 CALLS AND PUTS
Long/Short
European and American
Out of money, at the money, in the money

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OTHER ALTERNATIVE
INVESTMENTS
REITS: Real Estate Investment Trusts
Commodities (low correlation)
Currency
Hedge Funds (low correlation)

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MUTUAL FUNDS
Pools of money invested in equities, fixed income, alternatives of
some combination
Mutual funds have shares. Value of each share is its net asset value
(NAV)
Value of NAV is calculated every day at end of trading day (4PM
EST)
Types:
 Open ended: It can issue as many shares to satisfy demand
 Closed end: has a specific number of shares. Shares are traded at bid/ask and such
price might be different than NAV

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ETFS
ETFs – investment funds, traded on exchanges (like stock), trades
close to NAV.
Most track index, low cost, tax efficient, stock-like

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BENCHMARKS
Benchmark is a composite of all the securities that have certain
characteristics and follow specific rules about size, liquidity, issuer,
market, etc.
Most widely used benchmarks are
 Dow Jones: average price of one share of 30 companies
 S&P: average market value of 500 large companies
 Russell: like Russell 2000
 MCSI, usually used for EM
 Barclays Aggregate

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ACTIVE VS. PASSIVE

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TRACKING ERROR
* Tracking error: measures the inconsistency in return/ how
consistent is manager under our outperforming. Cons: does not
distinguish between out/under performance
* Typical TE
Strategy  TE 
Index  0% 
Enhanced  1%-2% 
Active  4%-7% 
Ultra active  10%-15% 

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TRACKING ERROR
Low TE vs. High TE

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 TRACKING ERROR
Typical Values?

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INFORMATION RATIO
Information Ratio: how consistent is the PM.
How great is the benefit of active management. 
Higher IR=>more consistent/greater benefit of active management. 

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USE OF BENCHMARK
Benchmarks are used to:
 Describe the market (what is in or out)
 Proxy for a specific market (e.g. US fixed income, US stocks, International stocks,
etc)
 Calculate performance for the market and use it as proxy
 Overweight or Underweight the index (use it as a yardstick)

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DAY 1.1 - PORTFOLIO
MANAGEMENT
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RETURN

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VARIANCE

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COVARIANCE

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56
 THE MINIMUM-
VARIANCE PORTFOLIO
• Is one that has the smallest variance among all
portfolios with identical expected return

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 THE MINIMUM-VARIANCE
FRONTIER

• Is a graph of the expected return/variance

combinations for all minimum variance
portfolios

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 DIVERSIFICATION
Diversification is reducing risk by combining many different types of assets
into one portfolio
Lower correlation means greater diversification
More assets=more diversification

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CAPITAL ALLOCATION
LINE
In reality, investors usually allocate across both risky and risk-free
assets

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CAL
When combined with a risk free asset, investor should choose the
risky portfolio that maximizes the reward-to-risk tradeoff

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CAPITAL MARKET LINE
Is the capital allocation line in a world in which all investors agree on
the expected returns, standard deviations and correlations assets – all
towards an optimal risky portfolio

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CAPITAL ASSET PRICING
MODEL
CAMP provides a way to calculate an asset’s expected return based
on its level of systematic risk, as measured by asset’s beta.

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SECURITY MARKET LINE
Is the graph of the CAMP

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MULTIFACTOR MODELS
Assumes asset returns are driven by more than one factor
 Macro models (GPD. Rates, inflation)
 Fundamental models (P/E, market cap, earnings growth rate, etc)
 Statistical models (mystery factors)

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DAY 2: PRIVATE
WEALTH
MANAGEMENT
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INVESTMENT POLICY

IPS is a written document that provides guidelines for portfolio

investment decision making. The IPS does the following:
 Provides guidance for the investment adviser
 Promotes long-term discipline
 Protects against short-term shifts

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IPS
Elements in an IPS are:
 Description of client's situation
 Purpose
 Identification of responsibilities
 Objectives and constraints
 Schedule for performance review
 Asset allocation ranges, guidance on rebalancing

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RISK TOLERANCE
QUESTIONNAIRES
Are documents that help advisors gauge time horizon and risk
aversion.
Once these 2 elements have been established, a portfolio is assigned
to that investor.

What is your ability and willingness to accept uncertainties in your

investment’s performance?

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AGENCY PROBLEM
A conflict of interest inherent in any relationship where one party is
expected to act in another's best interests. The problem is that the
agent who is supposed to make the decisions that would best serve
the principal is naturally motivated by self-interest, and the agent's
own best interests may differ from the principal's best interests. The
agency problem is also known as the "principal–agent problem.

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AGENCY PROBLEM
How do investment managers get paid?
Are their incentives fully aligned with investors’?
Taking one step back, what about conflict of interest between a
company's management and the company's stockholders?
Do CEOs or portfolio managers share the losses?

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BENCHMARKS
Equity
 S&P
 Russell
 MSCI

Fixed Income
 Barclays

Other:
 T bill or T bill + spread

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S&P

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RUSSELL INDEXES

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MSCI

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FIXED INCOME

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 DAY 3:
INSTITUTIONAL
MARKETS
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US MARKET SIZING

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WHICH CHANNELS ARE
GROWING THE MOST?

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BREAKDOWN OF
PROFESSIONALLY MANAGED
ASSETS BY TYPE OF CLIENT

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BREAKDOWN OF
PROFESSIONALLY MANAGED
ASSETS BY TYPE OF CLIENT

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 INSURANCE – GENERAL
ACCOUNTS MANAGEMENT
U.S. Insurance General accounts represent a $7.3 trillion institutional asset
pool in 2020.

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IRA MARKET

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TOP US WEALTH
MANAGERS

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WHAT'S BREAKDOWN OF
US MUTUAL FUND ASSETS?

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ACTIVE VS PASSIVE
FUNDS

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TOP OPEN-END MUTUAL
FUND MANAGERS

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TOP MONEY MARKET MUTUAL FUND
MANAGERS

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TOP CLOSED-END MUTUAL FUND
MANAGERS

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ETFS

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ETFS

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TOP-20 ETF SPONSORS
(WORD MANAGER IS NOT
USED)

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DEFINED BENEFIT PLANS

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ASSET ALLOCATION OF
DB PLANS

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TOP PENSION PLAN
MANAGERS

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LARGEST PENSION
PLANS?

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DEFINED CONTRIBUTION
PLANS (401KS)

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DEFINED CONTRIBUTION
PLANS (401KS)

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TOP DEFINED
CONTRIBUTION MANAGERS

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TOP TARGET-DATE FUNDS

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TOP RECORDKEEPERS

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ENDOWMENTS AND
FOUNDATIONS

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TOP ENDOWMENTS AND
FOUNDATIONS MANAGERS

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 NEW TRENDS
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ESG DIRECT
INVESTMENTS INDEXING
DEMAND FOR ESG
STRATEGIES IS ON THE
RAISE

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DIRECT INDEXING

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DAY 4: ARTIFICIAL
INTELLIGENCE
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 WHAT IS ARTIFICIAL
INTELLIGENCE?
Applications of technology to perform tasks that resemble
human cognitive function 

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 WHAT IS CAUSING THE
ACCELERATION OF AI?
Data economy:
 Refers to how much data has grown over the past few years and how much more I can
grow in the coming years

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 TYPES OF ARTIFICIAL
INTELLIGENCE?
1. Reactive Machines
2. Limited Memory
3. Theory of Mind*
4. Self Aware*

*Exist only in theory

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 REACTIVE MACHINES
Perform basic operations
It’s the simplest
No learning involved

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 LIMITED MEMORY
Limited ability to store previous data
And using that data to make better predictions
3 types:
 Reinforcement learning: use in games like chess
 Long Short Term Memory: used to predict next elements in a sequence
 Evolutionary Generative Adversarial Networks: this model produces a kind of growing thing
– and growing things don’t take the same path every time, the paths get to be slightly
modified because statistics is a math of chance

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 THEORY OF MIND
Starting to develop
Seen in self-driving cars
A.I. begins to interact with the thoughts and emotions of humans (Alexa or
Siri don’t get mad or give you emotional support)

A Theory of Mind A.I. will be a better companion

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 SELF-AWARE

In the future, A.I. will become self-aware

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 ARTIFICIAL
INTELLIGENCE IN
FINANCE
COVID-19 has forced banks and financial institutions to respond to
customers at an even faster pace
Artificial intelligence’s benefits are:
 free up personnel
 improve security measures
 ensure that the business is moving in the right technology-advanced direction

115
 ARTIFICIAL
INTELLIGENCE IN
FINANCE
Examples:
 Risk assessment: loan approval
 Loan eligibility
 Loan options
 Credit decision
 Fraud Detection
 Pinpoint trends
 Buyer’s behavior analysis
 Enabling 24/7 customer support
 Use of bots to answer FAQs

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 ARTIFICIAL
INTELLIGENCE IN
INVESTING
A.I can draw insights from data faster and more efficiently than humans
Helping people find new investment opportunities, removing bias from
decision-making
Serve more clients effectively (bring scale to market – robo advisors)

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 ARTIFICIAL
INTELLIGENCE IN
INVESTING
Examples are:
 Algorithmic trading opportunities
 At closing prices
 Follow momentum
 Small trades
 Smarter retirement planning
 Portfolio design based on your specific needs
 Dynamic forecast for income and spending
 Decrease Human biases
 Prove advice: encourage behavior (more contributions) Discourage behavior (redeem)
 Rebalancing opportunities

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DAY 5: BEHAVIORAL
FINANCE
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 BEHAVIORAL FINANCE
Traditional finance focuses on how individuals should behave
Behavioral finance is descriptive, which focuses on describing how
individuals actually behave
This is framework for the analysis of decision-making:
 Normative analysis. The optimal rational solution per the assumptions of traditional finance.
This is the solution decisions should strive to emulate.
 Descriptive analysis. Focusing on how individuals actually make decisions based on
behavioral finance.
 Prescriptive analysis. Advice and tools aimed at aligning actual behavior with the normative
ideal.

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 BEHAVIORAL FINANCE
Every day, the average person makes between 2,000 and 10,000 decisions
Rather than following the processes and steps of a rational economic man
(REM), individuals use shortcuts, rules of thumb, and intuition
Behavioral finance asserts that biases are not simply errors, which are
random, but are systematic and therefore predictable.
Two types:
 Cogitative errors
 Emotional biases

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 BEHAVIORAL FINANCE
Every day, the average person makes between 2,000 and 10,000 decisions
Rather than following the processes and steps of a rational economic man
(REM), individuals use shortcuts, rules of thumb, and intuition
Behavioral finance asserts that biases are not simply errors, which are
random, but are systematic and therefore predictable.
Two types:
 Cogitative errors
 Emotional biases

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 COGNITIVE ERRORS
Due primarily to faulty reasoning
Easier to mitigate
Divided further between:
 Believe of perseverance: decide to stick with previous decision - 5 errors
 Processing errors: information analysis is flawed - 4 errors

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COGNITIVE ERRORS
1. Conservatism bias: rationally form an initial view but then fail to change that view as
new information becomes available
2. Confirmation bias: look for new information or distort new information to support an
existing view
3. Representativeness bias: the past will persist and new information is classified based
on past experience or classification
4. Illusion of control bias: market participants think they can control or affect outcomes
when they cannot
5. Hindsight bias: selective memory of past events; tendency to see things as more
predictable

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COGNITIVE ERRORS
1. Anchoring: Changes are made but in relation to the
initial view and therefore the changes are inadequate
2. Mental accounting bias: money is treated differently
depending on how it is categorized
3. Framing bias - when decisions are affected by the way
in which the question or data is "framed.“
4. Availability bias - undue emphasis on the information
that is readily available

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EMOTIONAL BIASES
• Six biases generally arise from emotion and feelings
rather than any conscious thought
• Some may look like the previous errors, but it all
depends where they come from:
• If from unconscious: behavioral
• If from faulty thought process, cognitive

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EMOTIONAL BIASES
1. Loss-aversion bias: feeling more pain from a loss than
pleasure from an equal gain
2. Overconfidence bias: market participants overestimate
their own intuitive ability or reasoning
3. Self-control bias: individuals lack self-discipline and
favor immediate gratification over long-term goals
4. Status quo bias: comfortable with the existing situation
5. Endowment bias: sset is felt to be special and more
valuable simply because it is already owned – sentimental
6. Regret-aversion bias: do nothing out of excess fear that
their actions could be wrong

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 Presentation on a global asset
manager

CASE STUDY Contrast 2 business

models: Transamerica
and Neuberger Berman
Human Capital
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DIFFERENT BUSINESS
MODELS FOR ASSET
MANAGERS
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PURE ASSET MANAGER
After DB and DC as well as
retail funds

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DISTRIBUTOR
After retail funds and some DC

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PLAN SPONSOR
After all DC and some retail
Sell to Employers

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 PLAN PROVIDERS
After all DC and some retail
Sell to Employers (plan sponsors)
Also sell record-keeping capabilities
and custody services

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 ONLINE BROKER
After retail, investments and retirement

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 ROBO-ADVISORS
New normal or just an extension of the traditional brokerage business?

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TAMP/MANAGED
ACCOUNTS

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ALL OF THE ABOVE

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