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26 Cards in this Set
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Equity Portfolio Management
3 different approaches to portfolio management (SS11) |
1. Passive (index)
0-1% tracking risk IR = 0 2. Semiactive (enhanced indexing) 1-2% tracking risk IR = 0.75 3. Active 4% tracking risk IR = 0.5 |
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Equity Portfolio Management
Equity Index weighting choices (SS11) |
1. Price weighted - weighted like you bought one share of each stock.
Bias: Towards highest priced share 2. Value (or float) weighted - like you held all outstanding shares. Issues here are the 'free float' Bias: Towards largest/mature market cap and overvalued companies. BEST (despite this) it is the market standard. 3. Equal weighting - same amount of money is invested in each stock. Bias: Towards small companies. Limitation: Not all small issues have enough shares to meet demand. |
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Equity Portfolio Management
Example - Price weighting an Index (SS11) |
Add all the raw prices together and get an average.
Period Start 35.04 + 16.08 +15.57 ------------------------------- = $33.34 3 Period End 24.85 + 24.09 + 31.36 --------------------------------- = $26.76 3 Return 26.76 - 33.34 -------------------- = -0.25 or 25% 33.34 |
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Equity Portfolio Management
Example - Float weighting an Index (SS11) |
1. Multiply out the market value by the free float factor.
2. Effectively reduces the weight on companies who have less shares in free float. 3. If low free float stocks do poorly it is going to increase the returns of the index (because they have less weight) |
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Equity Portfolio Management
Equity mutual funds differ from ETF how? (SS11) |
1. Accounting:
ETF's have no accounting Mutual fund has accounting at the fund level which can be expensive. 2. Index license fees ETF's have to pay them (BAD) Mutual funds don't have to pay them (GOOD) 3. Tax ETF's are more tax efficient Mutual Funds buying and selling triggers tax events which may no be ideal to their investors. 4. Transaction Costs ETF initial trade commission is high, but low ongoing Mutual funds have higher ongoing trading expenses. |
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Equity Portfolio Management
Two ways to build an index-tracking portfolio (SS11) |
1. Stratified Sampling - divide into cells like market cap large/small, industry types, value, growth types.
i. The more cells, the more it will track the index ii. The more dimensions within the cell, the more it will track the index. 2. Optimization - Mathematical approach i. Advantages: Takes into account covariances among factors ii. Disadvantages: Imperfect specification. Impossible to match/estimate perfectly the risk factors. |
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Equity Portfolio Management
Passive Investment Vehicles (SS11) |
1. Indexed Portfios - stratified or optimization
2. Equity Index Futures - portfolio or 'basket' trades and stock index futures. 3. Equity Total Return Swaps - at least one side of the swap involves an index, the other can be an ir or whatever. |
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Equity Portfolio Management
What do value investors try and do? What do growth investors try and do? (SS11) |
Value investors
1. More concerned with buying stock that is 'deemed' relatively cheap in terms of the purchase price or earnings or assets MORE THAN the company's future growth prospects 2. Value has substyles of low P/E, contrarian and high yield. 3. Main Risk: Misinterpreting a stocks cheapness. It may be cheap for a good economic reason. Growth Investors 1. More concerned with EARNINGS GROWTH. 2. Growth has substyles of i. consistent growth and ii. earnings momentum 3. Main risk: Forecasted EPS fails to materialize as expected. |
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Equity Portfolio Management
Returns Based Style Analysis (contrasted to holdings-based style analysis) (SS11) |
1. Beta's on indices are non-negative and sum to 1
2. Example: Beta large cap value = 0.75 Beta large cap growth = 0 Beta small cap value = 0.25 Beta small cap growth = 0 These are the 'style weights' 3. Think 'style-fit' here where: R2000V = 0 R2000G = 0.039587 R1000V = 0.388712 R1000G = 0.5717 Weights sum to one. |
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Equity Portfolio Management
Holdings Based Style Analysis (SS11) |
Holdings based categorizes individual securities by their characteristics and then sums them up to decide what style it is AFTER the fact.
(Style-based picks the style first, holdings-based pick the holdings first then decides the style based on what is held) i. Value likes low P/E ii. Growth likes +ve earnings momentum iii. Growth has low dividend payout ratios iv. Value likes high earnings variability because of their willingness to hold companies with cyclical earnings. v. Value overall likes finance and utilities vi. Growth likes IT and healthcare. |
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Equity Portfolio Management
Returns Based vs Holdings Based (SS11) |
Returns (classify as value or growth)
i. GOOD cost effective and can be done quickly ii. GOOD theoretical basis and allows comparison across pfs. iii. BAD can be ineffective in characterizing current style. Holdings (classified by sector, then utilities is seen as more of a value play) i. BAD because it's more data intensive that returns-based ii. BAD because no managers use it iii. GOOD allows you to compare each position |
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Equity Portfolio Management
Style Drift (SS11) |
Style Drift
1. BAD because investor may no longer have exposure to the particular style desired 2. BAD because the manager may be operating outside her area of expertise. |
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Equity Portfolio Management
Long-Short Investing (SS11) |
Long-short investing has TWO alphas (long only has one alpha)
1. Pairs trade - e.g. long a perceived undervalued stock like Ford and short a perceived overvalued stock like GM. 2. Greatest risk with long-short is leverage. It magnifies any loss on the short term loss because you have to sell out to meet margin calls. |
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Equity Portfolio Management
Price Inefficiency on the Short Side (SS11) |
Price inefficiencies on the short side
1. Short selling impediments, means few investors look for overvalued stocks 2. Management fraud creates an opportunity to short 3. Sell-side analysts issue more 'buy' reports than sell recommendations. Anyone can buy so everyone might be interested, but the only people who want to know about sells are those who already hold the stock. 4. Sell-side analysts are always +ve about a company. If they are ever -ve then they will lose touch with management. 4. |
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Equity Portfolio Management
How does one equitize a Market-Neutral Long-Short Portfolio (SS11) |
1. "Equitizing" means giving it equity market systematic risk exposure.
2. This exposure is taken by buying long futures with notional values equal to the cash position you have from shorting other securities. A 'true' long-short is built around a cash benchmark (whereas a long only can only have a max short weight of that stocks index weight e.g. 4% AA and active weight would be -4%) 3. Equitizing is adding an EQUITY BETA. 4. Returns should be benchmarked against the index equitizing instrument. |
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Equity Portfolio Management
Long-Short Investing (SS11) |
1. Price inefficiency on the Short Side
2. Equitize a Market Neutral Long-Short Portfolio - when you want to add equity beta. Adv: Market return and alpha are able to be earned from DIFFERENT sources. Beta = Zero for equitized long-short. 3. Long-Only Constraint - max short you can do on this is to not own the long position 4. Short Extension Strategies - specify the level of short selling. Costs here are the trade execution costs and stock loan fees paid for lending on the short side. This partially relaxes the long only constraint. Disadvantage of short extension: they gain their market return and alpha from the SAME SOURCE. |
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Equity Portfolio Management
Sell Disciplines (SS11) |
1. Value investors typically have low turnover
2. Growth investors try to capitalize on growth and stability. Growth has higher turnover than value. |
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Equity Portfolio Management
Semiactive Equity Investing (SS11) |
1. Has the highest IR (information ratio)
2. Takes on a little more tracking risk for more return to cover trading costs. 3. Neutralizes the portfolio's risk characteristics. 4. Fundamental Law of Active Mangement IR = IC √Breadth Means that the information ration is about equal to what you know about a given investment (the information coefficient) i. lower breadth strategy needs more accurate insight about a given investment to produce the same IR as a strategy with a higher breadth. ii. Breadth is the number of independent active investment decisions. |
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Equity Portfolio Management
Example - Fundamental Law of Active Management (SS11) |
Gerhardt Holz is evaluation two investment managers
i. Manager A follows 500 stocks with annual forecasts, and the IC for each of the forecasts is 0.03 ii. Manager B follows 100 stocks with annual forecasts, and the IC for each of the forecasts is twice that of Manager A's security forecasts. Based only on this information, which manager should Holz select? i. Manager A's breadth of 500 and IC of 0.03 translates into an IR IR = 0.03 √500 = 0.67 (annually) ii. Manager B's breadth of 100 and IC of 0.06 translates into an IR = 0.06 √100 = 0.6 (annually). iii. Based on this information, Holz would select Manager A |
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Equity Portfolio Management
Example - Derivatives-Based vs Stock-Based Semiactive Strategies (SS11) |
Thinking about investing in enhanced index products? What are your alternatives
1. Stock-based vs Derivative-based semiactive investment i. stock based semiactive controls over-under weighting of securities relative to their index weights. ii. Tries to pick up active return by insights iii. derivative based (on the other hand) uses derivatives to equitize cash and try to pick up active return by adjusting duration of fixed income position. 2. Which criterion do you use to evaluate these? i. The IR information ratio ii. defined as mean active return iii. divided by tracking risk iv. it is the best because it shows a comparison based on the mean active return gained for bearing a unit of active risk in each strategy. 3. Recommend and justify a semiactive approach for the pension plan i. Stock-based semiactive has IR IR = 1.2/2.7 = 0.44 ii. Derivatives-based semiactive has IR = 1/2.1 = 0.48 iii. Because derivatives has the higher information ratio, the recommendation is to use a derivative-based strategy. |
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Equity Portfolio Management
Managing a Portfolio of Managers (SS11) |
1. Investors trade off
Active Return vs Active Risk i. lower active riskers choose to index ii. higher active riskers choose an active manager. 2. (Asset Allocation does the total return vs total risk) |
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Equity Portfolio Management
Example - Evaluating Core-Satellite portfolio against pension funds motives (SS11) |
Man. A 400m alpha = 0 TR = 0%
Man. B 100m alpha = 2% TR = 4% Man. C 100m alpha = 4% TR = 6% Man. D 100m alpha = 4% TR = 6% 1. What is Man. A's style? i. Indexer, with 0% alpha and 0% tracking 2. What is the structure of the optimal portfolio of managers? Man. A is the core with more than half the portfolio's value and B,C and D are the active 'satellite' portfolios surrounding the core. 3. Calculate expected alpha and tracking risk for portfolio. i. Alpha 4/7 (0%) + 1/7 (2%) + 1/7 (4%) + 1/7 (4%) = 1.43% ii. Tracking risk is √ [ (4/7)²(0%)² + (1/7)²(4%)² + (1/7)²(6%)² + (1/7)²(6%)² ] = 1.34% (nb: remember square root) In conclusion, the portfolio managers meet the performance requirements of the trustees. Note that the tracking risk calculation used the assumption that the manager's alphas are UNCORRELATED |
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Equity Portfolio Management
Two Parts to Active Return (SS11) |
Two parts to active return
1. True active Manager's return - Man. benchmark 2. Misfit active Man. benchmark - Investor's benchmark 3. Together they are TOTAL ACTIVE RISK Total active = √ [ true² + misfit² ] (nb remember the square root) |
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Equity Portfolio Management
Example - True and Misfit (SS11) |
i. Manager C (alpha 4 tracking 6) is a value-oriented manager
ii. the MSCI World ex-Aus Value Index represents Man. C's investment universe iii. Man.C the MSCI World ex-Aus Index (normal benchmark) and the MSCI World ex-Aus. Value Index (actual benchmark) return 12%, 10% and 15% per year for a given time period. iv. Man C's total active risk computed with respect to MSCI World ex-Aust is 5.5% annually. The manager's 'misfit' risk is 4 % annually. 1. Manager's "true" active return is 12% - 15% = - 3% 2. Manager's "misfit" active return is 15% - 10% = 5% Here the value stocks just happened to outperform, NOT his ability to trade value stocks. |
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Equity Portfolio Management
What is a completeness fund? (SS11) |
A completeness fund:
1. Seeks to neutralize unintented bets from summing up all the managers positions. 2. After you have pooled together all your managers, you may find that you have an unintended industry bet. Use a completeness fund to balance this. |
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Equity Portfolio Management
Alpha and Beta Separation (SS11) |
1. Long active
i. exposure to market beta ii. exposure to manager's alpha 2. Market neutral long-short i. NO exposure to market beta ii. exposure to manager's alpha 3. Potable alpha i. you can cover other styles or asset classes OUTSIDE the beta asset class |
