Momentum and Behavioural Finance

Question 1Momentum and Behavioural Finance

(i) Momentum strategies have been shown to earn excess risk-adjusted returns across every developed stock market. Using examples from specific funds, explain carefully what constitutes a momentum strategy and whether you would recommend using momentum in your own portfolio.

(ii) Behavioural finance research has uncovered a catalogue of biases among investors that appear to contradict market efficiency. Choose any two (2) biases and critically evaluate their relevance for somebody working as a private client investment advisor.

Question 2 Risk Management in a Crisis

In the aftermath of the 2007-8 Global Financial Crisis, Andrew Haldane, Chief

Economist, Bank of England in a speech entitled ‘Why Banks Failed the Stress Test’concluded that:

“Risk management models have during this crisis proved themselves wrong in a more fundamental sense. They failed Keynes’ test – that it is better to be roughly right than precisely wrong. With hindsight, these models were both very precise and very wrong.”

Required: Critically evaluate Haldane’s statement in the context of modern risk management methods such as Value-at-Risk; the evolution in risk management since the Global Financial Crisis; and a series of high-profile rogue trader and operational risk episodes.

What are the key lessons that can be drawn from these issues for the future of risk management?

Question 3 Passive vs. Active Investing

In his 2018 letter to Berkshire Hathaway shareholders, Warren Buffett stated:

“When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost funds.”

Required: Critically appraise the arguments as to whether fund managers should therefore use purely passive investment strategiessuch as exchange traded funds (ETFs) or index funds or whether investors should use, for example, a combination of active and passive strategies when constructing a portfolio.

Use your own examples of what investments you might recommend in constructing such a portfolio.

Points to be noted

1. Use graphs or tables when ever required.

2. Not more than 4000 words excluding the tables and graphs.

3. Please use the Harvard referencing style.