The document summarizes various passive and active equity portfolio management strategies. It discusses why equities are included in portfolios, the differences between passive and active management, and various passive strategies like full replication, sampling, and quadratic optimization. It also covers value and growth investing styles, benchmark portfolios, timing between styles, and active strategies like fundamental, technical, exploiting anomalies and attributes. Finally, it summarizes asset allocation strategies like integrated, strategic, tactical, and insured asset allocation and factors to consider when selecting an active allocation method.
4. Why equities in a portfolio?
• Equities have historically served as a good
inflation hedge. When-
Inflation can be priced into the stock.
Inflation can be passed through the
consumer.
• Provides a growth dimension to the
portfolio.
5. Passive versus Active Management
• Passive equity portfolio management
– Long-term buy-and-hold strategy,
– Usually tracks an index over time,
– Designed to match market performance,
– Manager is judged on how well they track the
target index.
6. Passive versus Active Management
• Active equity portfolio management
– Attempts to outperform a passive benchmark
portfolio on a risk-adjusted basis.
8. An Overview of Passive Equity Portfolio
Management Strategies
Replicate the performance of an index.
May slightly underperform the target index
due to fees and commissions.
Costs of active management (1 to 2 percent)
are hard to overcome in risk-adjusted
performance.
Many different market indexes are used for
tracking portfolios.
10. Full Replication
• All securities in the index are purchased
in proportion to weights in the index.
• This helps ensure close tracking.
• Increases transaction costs, particularly
with dividend reinvestment.
11. Sampling
• Buys a representative sample of stocks in the
benchmark index according to their weights
in the index.
• Fewer stocks means lower commissions.
• Reinvestment of dividends is less difficult.
• Will not track the index as closely, so there
will be some tracking error.
12. Expected Tracking Error Between the S&P 500
Index and Portfolio Comprised of Samples of Less
Than 500 Stocks
Exhibit 16.2
500 400 300 200 100 0
2.0
1.0
3.0
4.0
Expected Tracking Error
(Percent)
Number of Stocks
13. Quadratic Optimization
(or programming techniques)
• Historical information on price changes and
correlations between securities are input
into a computer program that determines
the composition of a portfolio that will
minimize tracking error with the benchmark.
• This relies on historical correlations, which
may change over time, leading to failure to
track the index.
14. Methods of Index Portfolio Investing
• Index Funds
– Attempt to replicate a benchmark index.
• Exchange-Traded Funds
– EFTs are depository receipts that give
investors a pro rata claim on the capital gains
and cash flows of the securities that are held
in deposit by a financial institution that issued
the certificates.
19. Value versus Growth
Growth stocks will outperform
value stocks for a time and then
the opposite occurs.
Over time value stocks have
offered somewhat higher returns
than growth stocks.
20. Value versus Growth
• Growth-oriented investor will:
focus on EPS and its economic
determinants.
look for companies expected to have
rapid EPS growth.
assumes constant P/E ratio.
21. Value versus Growth
• Value-oriented investor will:
–focus on the price component.
–not care much about current earnings.
–assume the P/E ratio is below its
natural level.
23. Style
• Construct a portfolio to capture one or more
of the characteristics of equity securities
• Small-capitalization stocks, low-P/E stocks,
etc…
• Value stocks appear to be underpriced
– price/book or price/earnings.
• Growth stocks enjoy above-average earnings
per share increases.
24. Determining Style
• Style grid:
– firm size (large cap, mid cap, small cap).
– Relative value (value, blend, growth)
characteristics.
• Style analysis
– constrained least squares.
25. Benchmark Portfolios
• Sharpe
– T-bills,
– intermediate-term government bonds,
– long-term government bonds,
– corporate bonds,
– mortgage related securities,
– large-capitalization value stocks,
– large-capitalization growth stocks, medium-capitalization
stocks,
– small-capitalization stocks,
– non-U.S. bonds,
– European stocks,
– and Japanese stocks
26. Benchmark Portfolios
• Sharpe
• BARRA
– Uses portfolios formed around 13 different
security characteristics,
– including variability in markets, past firm
success, firm size, trading activity, growth
orientation, earnings-to-price ratio, book-to-
price ratio, earnings variability, financial
leverage, foreign income, labor intensity, yield,
and low capitalization
27. Benchmark Portfolios
• Sharpe
• BARRA
• Ibbotson Associates
– simplest style model uses portfolios formed
around five different characteristics:
– cash (T-bills), large-capitalization growth, small-
capitalization growth, large-capitalization value,
and small-capitalization value
28. Timing Between Styles
• Variations in returns among mutual
funds are largely attributable to
differences in styles
• Different styles tend to move at
different times in the business cycle
30. An Overview of Active Equity
Portfolio Management Strategies
Total actual return= expected return + alpha
Management strategies
Fundamental strategies.
Technical strategies .
Market anomalies and attributes.
Tax efficiency and active equity portfolio .
31. Fundamental strategies
Active fundamental managers use three
generic themes.
Asset class rotation strategy
Shifting fund in and out of the stock market
depending managers perception how stock is
value compared to the various asset class
alternative.
Sector rotation strategy.
130/30 strategy.
32. Technical analysis
Contrarian investment strategy.
Base other belief that the best time to a stock is
when the majority other investors are the most
bearish or bullish.
Price momentum strategy.
Earnings momentum strategy.
33. Disadvantages: technical analysis
Past price pattern may not be repeated in the
future.
The intense competition of those using the trading
rules will render the technique useless.
The values that signal action constantly changing.
35. Tax efficiency and active equity
management
• Passive equity portfolio.
• Active equity portfolio.
• Pension fund and university endowment funds.
• Tax cost ratio.
38. Integrated Asset Allocation
The integrated asset allocation strategy examines,
capital market conditions and investor’s objectives
and constraints .These factors are combined to
establish the portfolio asset mix .
39. Strategic Asset Allocation
Strategic asset allocation is a constant mix asset
allocation with periodic rebalancing to adjust the
portfolio to the specified asset weights.
41. Insured Asset Allocation
Insured asset allocation results in continual
adjustment in the portfolio allocation assuming that
expected market returns and risk are constant over
time.
42. Selecting an Active Allocation
Method
-Depend on the perceptions of the variability
-Perceived relationship between past and future
capital market condition.
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