3 - Equities

Question 1

Explanations for beta/volatility anomaly

Answer 1

Investors are leverage constrained so they choose high beta stocks to tilt their portfolios towards high volatility. Psychological preference for lottery stocks.

Question 2

Typical portfolio construction (equities)

Answer 2

Build Signals

Combine Signals

Neutrality (beta, market, cash, vol, size neutral)

Control risk across sectors, regions signals

Volatility targeting

Active weights constraints (region-level, stock-level)

Turnover constraints (minimize tracking error, overall turnover constraint)

Question 3

What is turnover

Answer 3

When a trading strategy involves high levels of turnover, it means that the portfolio’s holdings are being frequently replaced. Problem: trading costs, bid-ask spreads, etc.

Question 4

Value measures in equities

Answer 4

Book-to-market, div yield, earnings yield, sales yield, ROA

Question 5

Behavioural vs. Risk explanations of Value

Answer 5

Behavioural: Overreaction of investors to growth stocks.

Risk: Value stocks tend to struggle in deleveraging when times are bad -> high book values, when they can get over the slump they find themselves in good positions.

Question 6

Factors that could slowdown/speed-up pricing of information

Answer 6

Community attention (# of analysts covering)
Size of firm
Complexity of business
Directness of effects

Question 7

Standardized Unexpected Earnings (SUE)

Answer 7

Rank stocks on surprise vs. analyst consensus (analyst consensus is not a “direct” measure)

Question 8

Earnings Announcement Returns (EAR)

Answer 8

Rank based on earnings around announcement dates (3 days), holds for following quarters. More robust, incorporates other information like sales, margins, investment.

Question 9

Problem with Earnings Momentum?

Answer 9

Getting harder and harder to exploit, especially in mature markets

Question 10

How to avoid Momentum crashes?

Answer 10

To some extent by controlling for beta and volatility

Question 11

Five factor model factors:

Answer 11

Value, Size, Quality and Investment.

Question 12

What is Quality in the context of FF5

Answer 12

Usually associated with profitability and safety of the firm. Metrics like: Operating Cash Flow over Assets (how much cash it’s generating in core business); Cash Return on Capital Invested; ROE; Distance to default.

Question 13

What is Investment in the context of FF5

Answer 13

Consists in portfolios formed on negative change in total assets. Logic: avoid firms over-investing.

Question 14

What are Governance factors

Answer 14

Investment, financing and accruals, based on the feeling that management knows best.

Question 15

Financing factors

Answer 15

Net cash flow from financing activities (stock issuance, repurchase and dividend payments)

Question 16

Accruals factors

Answer 16

Negative accruals to total assets (negative accruals mean that you have to receive more than you’ve spent)

Question 17

Insider factor

Answer 17

Net purchasing ratio to total insider transactions (are insiders buying or selling?)

Question 18

Controls BNP presentation

Answer 18

Volatility, Beta and Sector

Question 19

Build portfolios correctly (BNP)

Answer 19

Target exposure to known alpha factors: value, quality, momentum, low risk.
Avoid exposure to factors of risk with no alpha: sectors, beta.