active equity investing: port construction Flashcards
3 main blocks of portfolio construction
BRAP BRAP
+ rewarded factor weighting
+ alpha skills (timing)
+ position sizing
+ Breath of expertise
idiosyncratic risk
endemic risk / specific risk / unsystematic risk
information coefficient
correspond of which manager forecast active return and manager realized active return
breath
number of truthly dependence decisions made every year
transfer coefficient
the ability to translate from insight into investment decision without constraint
(unconstraint portfolio have TC = 1)
systematic
seeking return from a balance exposure
discretionary strategies
seek return form understanding in depth of:
+ firm governance,
+ business model
+ competitive lanscape
through successfull timing strategies
timing strategies
timing buy/ sell order before it go up /down
heuristic constraint
not formal constraint
well constructed portfolio
consistent with investor risk and return expectation
consideration between long-only and long/short strategy
RMCT P2L
+ regulatory constraints
+ management cost
+ capacity & scale
+ transaction comlexity
+ personal ideology
+ long-term risk premium
+ limited legal liability
130/30 strategy
long 1.3 time the amount of capital
short 0.3 capital
multi-factor manager
The manager concerned with balancing their factor exposure
gross exposure of portfolio
absolute level of a fund’s investments
3 Sources of Active Returns
(1) exposures to rewarded factors (lien quan den xay dung chien luoc dai han)
(2) . Tactical exposures to mispriced securities, sectors, and rewarded risks that generate alpha (lien quan den skill cua manager)
(3) Idiosyncratic risk (from concentrated active positions) that generates returns related to luck (an may)
what is sizing position
+ concentrate / unconcentrate
+ reduce / increase idiosyncratic risk
content of systematic top down
(1) emphasized rewarded factor
(2) factor timing possible but rare
(3) Formal portfolio organization used
(4) Diversification across broad universe
(5) Few managers in this category
Discretionary top down
(1) emphasize macro rewarded factors
(2) Most likely use factor timing
(3) Diversified on broad universe or focus on smaller subset
(4) Less formal portfolio construction
Systematic Bottom up
(1) Emphasize security specific factors
(2) No factor timing
(3) Diversified across board universe
(4) Formal portfolio optimization used
content of discretionary bottom up
(1) emphasize security specific characteristic / factors
(2) Potential factor timing
(3) Diversified or concentrated depending onstrategy and style
Description of pure indexing, active share, active risk
+ Description: No active position, porfolio = benchmark
+ Active share: = 0
+ Active risk = 0
Description , active share, active risk of Factor neutral
+ Description:
* No active factor bet
* idiosyncratic risk low if diversify
+ Active risk: low
+ Active return: low
Description , active share, active risk of Factor diversified
+ Description: balance exposure to risk factor, minimized of idiosycratic via high number of securities
+ Active share: reasonable low
+ Active risk: high from large security not form benchmark
Description , active share, active risk of concentrate factor bets
+ Description: target factor bets, idiosyncratic high
+ Active risk: high
+ Active share: high
Description , active share, active risk of concentrated stock picker
+ Description: targeted stock pick
+ Active risk: highest
+ Active share: highest
when chose absolute risk ?
when the investment objective is expressed in terms of total returns
when chose relative risk
when the investment objective is to outperform a market index.
4 steps of An effective risk management process
+ S1: Determine which type of risk measure is appropriate given the fund mandate
+ S2: Understand how each aspect of the strategy contributes to risk
+ S3: Determine what level of risk budget is appropriate
+ S4: Properly allocate risk among individual positions/factors
market impact cost
an implicit cost related to the price movement caused by managers executing trades in the market
3 Factors that affect market impact costs
(1) Assets under management (AUM) versus market capitalization of securities:
(2) Higher portfolio turnover and shorter investment horizons generally lead to
higher market impact costs
(3) Managers whose trades include “information” will likely have higher market impact costs
well-constructed portfolio
(1) A clear investment philosophy and a consistent investment process
(2) Risk and structural characteristics as promised to investors
(3) Achieving desired risk exposures in the most efficient manner
(4) Reasonably low operating costs, given the strategy.
well-constructed portfolio
(1) A clear investment philosophy and a consistent investment process
(2) Risk and structural characteristics as promised to investors
(3) Achieving desired risk exposures in the most efficient manner
(4) Reasonably low operating costs, given the strategy.
Benefits of of Long/Short Strategies
+ Greater ability to express negative ideas
+ Ability to use the leverage generated by short positions to gear into high-conviction long ideas
+ Ability to remove market risk and act as a diversifying investment against other strategies
+ Greater ability to control exposure to risk factors
Drawbacks of Long/Short Strategies
+ Unlike a long position, a short position will cause the manager to suffer losses if the price of the security increases
+ Some long/short strategies require significant leverage -> manified loss as well as gain
+ The cost of borrowing securities can become too high, particularly for securities that are difficult to borrow
+ Losses on the short position will increase collateral demands from stock lenders, particularly if leverage has been used.
the reason of long/short strategies have higher IR
(1) Long only factor limit ability to short positions that not have desired characteristic
(2) Add ability to leverage negative/positive should improve TC and increase potential excess return
(3) Adding short can facilitate a more balance distribution of risk -> low cross correlations among factors -> reduce tracking error -> improving information ratio.
gross exposure vs net exposure
gross exposure = |long exposure| + |short exposure|
net exposure = long exposure + short exposure
slippage cost
the difference between the execution price and the
midpoint of the bid and ask quotes at the time the trade was first entered
4 conclusion of slippage cost
(1) Slippage costs are usually more important than commission costs
(2) Slippage costs are greater for smaller-cap securities than for large-cap securities
(3) Slippage costs are NOT necessarily greater in emerging markets
(4) Slippage costs can vary substantially over time, especially when market volatility is higher
what drawdown measure
measures the portfolio loss from its high point until it begins to recover
