Active equity investing - Strategies Flashcards
market microstructure
+ take advantage of mispricing due to imbalance in supply & demand
+ last for a few milliseconds
tool of market microstructure
+ traditional technical analysis
+ sotiphicated time-series analysis & econometric model
+ ML technique
event driven strategies
seek inefficiency occur around coporate event:
+ M&A
+ earnings & restructuring annoucement
+ share buy back
+ special dividends
+ spinoffs
pitfalls in fundamental investing
+ Behavioral bias
* Confirmation bias
* Illusion of control
* Availability bias
* Loss aversion
* Overconfidence bias
* Regret aversion bias
+ Value & growth trap
* Value trap: tuong lom nhung lom that
* Growth trap: grow ko dat nhu ky vong
holding-based approach
look at the attributed of each individual stock in portfolio and conclude overall style
What is return-based analysis ?
Adv to holding-based
+ identify through regression of the funds returns against a set of passive style indices
+ Easy to implement than holding-based
contrarian investing
Contrarian managers invest in stocks with low or negative earnings or low dividends -> expect the stocks to rebound.
Contrarian investors often point to behavioral finance research that suggests that investors tend to overweight recent trends and follow the crowd in making investment decisions. Therefore, contrarian investors purchase and sell shares against prevailing market sentiment.
Deep value investing
Deep value investing focuses on undervalued companies, which are often in financial distress, that are available at extremely low valuations relative to their assets. The rationale is that market interest in such securities may be limited, which increases the chance of informational inefficiencies
restructuring and disstressed
Opportunities in restructuring and distressed investing are generally counter-cyclical relative to the overall economy or a sector’s business cycle. A distressed company that goes through restructuring may still have valuable assets, distribution channels, or patents that make it an attractive acquisition target. The goal of restructuring investing is to gain control or substantial influence over a company in distress at a large discount and then restructure it to restore a large part of its intrinsic value
activist strategy process
S1: Activist Investors Identify Target Companies
S2: Buy Target Stock
S3: Study Corporate Structure, Governance, Shareholder Base, etc.
S4: Exit or Buy More Stocks?
S5: Submit Proposal to Company Management
S6: Reach Agreement? If not -> Threaten Proxy Contest
S8: Reach Agreement? If not -> Launch Proxy Contest
S9: Negotiate Settlement
S10: Reach Agreement? If not ? -> Shareholder Vote
value trap
+ stock are trading at low levels and present as buying opportunities for investors but are actually misleading
+ the low price is often accompanied by extended periods of low multiples as well
+ is a poor investment because the reason for the low price and low multiples is the company is experiencing financial instability and has little growth potential
Eg: TCB, VNH,…
growth trap
common investment mistake of assuming that a company (or an industry, or a country) is a good investment simply because there’s reason to believe that it will grow over the next several years
+ Mua xong ko tang truong nua
+ Hoac co tang truong, nhung da phan anh vao gia
behavior bias of fundamental approach
CAILOR
+ Confirmation Bias
+ Illusion of control
+ Availability bias
+ Loss aversion
+ Overconfidence bias
+ Regret aversion bias
4 charateristics of fundamental approach
+ User discretionary
+ Bottom - up and top - down
+ Use human judgement
+ Has pitfalls
3 characteristics of quantitative method
+ user rules-based quantitative model
+ systematic method, non-discretionary
+ has pitfalls
4 pitfalls of quantitative methods
SLDT
+ survivorship bias
+ look-ahead bias
+ data mining of over fitting
+ turnover, transaction costs, short availability
different between fundamental & quantitative method
+ fundamental method: subjective
+ quantitative method: objective
primary resources of fundamental method
+ human skills
+ experience
+ judgement
primary resources of quantitative method
expertise of statistical modeling
information use of fundamental approach
research (company/industry/economy)
information used of quantitative method
data and statistics
analysis focus of fundamental approach
conviction (high depth) in stock -, sector - , region-based selection
analysis focus of quantitative approach
a selection of variables, subsequently applied over a large number of securities
bottom up strategies based on in depth analysis of
+ business model
+ competitive advantages
+ company management
rationales of value based approach
+ Price will move to intrinsic value
+ Investors is irrational => opportunity
sub-style of value based approach
+ Relative value
+ Contrarian value
+ High quality value
+ Income investing
+ Deep value investing
+ Restructuring & Distressed investing
+ Special Situation
rationales of growth based approach
High earning growth will make price increase
sub-style of growth based approach
+ Consistent earning growth
+ Momentum
+ Growth at reasonable price
top down strategies based on
+ Macro economic environment
+ Demographic trends
+ Government policies
Instrument of top down strategies
+ ETFs
+ Swaps
+ Custom basket of individual stocks
style of top down strategies
+ Country and Geographic Allocation to Equities (Us vs UK)
+ Sector & Industry rotation (IT vs energy)
+ Volatility based strategy (VIX)
+ Thematic investment (disruptive technologies-process-regulation, innovation, economic cycle-oppotunities-challenges)
Factor based strategies based on ?
+ Significant factors that can predict future stock returns
+ Construct a portfolio that tilts towards such factors
activist strategy
hoc thuoc “activist investing process”
statistical arbitrage
Use Technical Analysis & Statistical => exploit anomalies to gain return
Eg: Pair trading
Event driven strategy
M&A
Eg:
+ Cash transaction: Buy target company stock
+ Stock transaction: Buy target company stock & short acquirer stock at the same exchange ratio
type of active investing stratergies based on approach
+ Fundamental approach
+ Quantitative approach
type of active investing stratergies based on strategies
+ Bottom up
+ Top down
sub type of active investing
+ Approach
+ Strategy
+ Style classifications
active strategies based on style classcification
+ Returns - based style analysis
+ Holdings - based style analysis
characteristic of Returns - based style analysis
+ Focus on characteristics of overall portfolio as revealed by portfolio’s return
+ Based on return:
* Return are regressed against the return of a set of securities indices
* Style fit is measured by coeffeccient of determination
+ Advantages:
* Qick
* Cost effective
* Minimal information
+ Disadvantages:
* Can not detect style drift quickly
+ Returns-based style analysis is preferred when the full details of the portfolio are not available
characteristics of Holdings - based style analysis
+ Verify a PM style by evaluating the characteristics of individual securities in portfolio and aggregate result to conclude overall style
+ Based on many more info
* Valuation level
* Earning variability
* Forecasted EPS growth rate
* Industry
+ Advantage
* Can detect style drift
* Up to date
+ Disadvantege
* Detail information
+ With holdings-based style analysis, portfolio managers can see how each portfolio holding contributes to the portfolio’s style and verify that the style is in line with the stated investment philosophy
Top-down strategies style focus on
+ geography,
+ industry,
+ equity style rotation,
+ volatility-based strategies,
+ thematic investment ideas
quantitative investment process
+ Defining the Market Opportunity (Investment Thesis)
+ Acquiring and Processing Data
+ Back-testing the Strategy
+ Evaluating the Strategy
+ Portfolio Construction Issues in Quantitative Investment
advantage of blended approach
Blended approach = Stratified sampling + Optimizatiion
+ Optimization: minimize tracking error
+ Stratified: number of stock smaller than benchmark
differences between bottom-up systematic and bottom-up discretionary
Targer:
+ low idiosyncratic risk
+ low concentrations
fundamental active investment process
- Define the investment universe and the market opportunity—the perceived opportunity to earn a positive risk-adjusted return to active investing, net of costs—in accordance with the investment mandate. The market opportunity is also known as the investment thesis.
2.Prescreen the investment universe to obtain a manageable set of securities for further, more detailed analysis.
- Understand the industry and business for this screened set by performing industry and competitive analysis and analyzing financial reports.
- Forecast company performance, most commonly in terms of cash flows or earnings.
- Convert forecasts to valuations and identify ex ante profitable investments.
- Construct a portfolio of these investments with the desired risk profile.
- Rebalance the portfolio with buy and sell disciplines.
pitfall of quantitative methods:
+ Survivorship bias
+ Look-ahead bias
+ Data mining (cố tìm ra sự liên quan nhưng thực ra không liên quan) or overfitting
+ Turnover, transaction cost, Short availability
Types of bottom-up strategies
(1) value-based
(2) growth-based
(3) Sub-styles
4 types of Top down strategies
(1) Country/geography
(2) Industry sector
(3) Volatility
(4) Thematic investment strategies
Thematic investment strategies focus on what ?
(1) new technologies,
(2) changes in regulations, and
(3) economic cycles
Drawbacks to the hedged portfolio approach
- The information in middle quantiles is lost in this approach
- It is assumed that the relationship between the factor and stock return is linear
- Portfolios can appear diversified when the manager uses multiple factors to select securities
- The approach assumes the manager can short stocks to create the hedged portfolio
- The hedged portfolio is not a “pure” factor portfolio because it will typically have significant exposures to other risk factors.
A factor mimicking portfolio
exposure to a chosen factor and an exposure of zero to other factors
factor timing
manager believes that different factors work well at different times
Activist Investing Process
(1) Screening and analysis of activist opportunities.
(2) Buying an initial stake in the target company (typically less than 10% of voting rights).
(3) Submitting a public proposal for changes to the company, usually in the form of an open letter to the company.
(4) If no agreement, threatening a proxy contest (a proxy contest is a shareholder vote to force the proposed changes on the company).
(5) If no agreement, launching a proxy contest.
(6) Continuing to negotiate with management, but with no agreement eventually taking the matter to a proxy contest.
Tactics Used by Activists
Seeking board representation (once attained this can be used to change
management).
Writing open letters to management detailing the changes, meeting with
management and engaging with other shareholders to court support in a proxy contest.
Proposing changes at an annual general meeting (AGM).
Proposing
type of Statistical Arbitrage
(1) Pairs trading
(2) Market microstructure-based
what is pair trading
Pairs trading identi two securities in the same industry that are historically highly correlated taking advantage of a temporary breakdown in this
relationship
what is Market microstructure-based
take advantage of mispricing last for a few milliseconds.
type strategies in Event-Driven Strategies
+ mergers and acquisitions,
+ earnings or restructuring announcements,
+ share buybacks,
+ special dividends, and
+ spin-offs
fundamental active investment process
(1) Define investment universe in accordance with the fund mandate.
(2) Prescreen the investment universe to obtain a manageable set of securities for detailed analysis.
(3) Analyze the industry, competitive position and financial report
(4) Forecast performance
(5) Convert forecasts to valuations
(6) Construct a portfolio with the desired risk pro
(7) Rebalance the portfolio as needed
Pitfalls in Fundamental Investing
(1) Behavioral biases
(2) value trap
(3) growth trap
quantitative active investment strategy has a well-defined process
(1) Define market oppotunity
(2) Acquire and process data
(3) Back-test the strategy
(4) Evaluate the strategy.
(5) Construct the portfolio
Pitfalls in Quantitative Investing
(1) Survivorship bias
(2) Look-ahead bias
(3) Data-mining/over
(4) Turnover
(5) Lack of availability of stock to borrow
(6) Transaction costs
quant overcrowding
occur if many
quantitative managers are following similar strategies.
two main approaches in style analysis
(1) holdings-based: base on attributes of each individual stock
(2) return based: identify the style of a fund through regression of
the funds returns against a set of passive style indices
Adv and Disadv of holding base/ return-base
….
GARP
grow at reasonable price
how to construction size factor
+ Construction: long small cap, short large cap
+ Rationale for risk premium: small cap at more risk of fail
how to construction value factor
Construction:
+ Long: cheap, high CF, high B/P
+ Short: opposite attribute
Rationale:
+ cheaper company easy being label financial distress -> bias
how to construction price momentum factor
Construction:
+ Long outperform
+ Short underperfom
rational: behavioral bias beleive this momentum being continue
how to construction growth factor
Construction:
+ Long: high historical/expected growth rate in earning/revernue/CF
+ Short: opposite
Rationale: indicator for strong performance
how to construction quality factor
construction:
+ Long:
* High quality earning
* Changes in debt level, profitability, stability, management efficiency measures
* Market sentiment
* Recent development
+ Short: opposite
Rationale: company with high earning, improvement sentiment is likely outperform
how to construction unstructured data factor
Construction:
+ Long: companies have largest customer trailing in 1 month
+ Short; opposite
market microstructure base arbitrage strategies
take advantage of mispricing opportunities occurring due to imbalances in supply and demand that are expected to only last for a few milliseconds
Heuristic risk constraints
- Definition: are based on experience or general ideas of good practice.
- Examples include limits on exposure to
+ individual positions,
+ sectors or
+ regions,
+ limits on leverage, or
+ measures designed to control the degree of illiquidity
+ turnover in the portfolio
Formal risk constraints
often statistical in nature, including limits on
+ volatility,
+ active risk,
+ skewness,
+ drawdowns, and
+ VaR-based measures
higher active weight, …. contribute more to portfolio active variance
A. higher
B. lower
A. higher
An asset will contribute more to a portfolio’s active variance if (1) it has a higher active weight and (2) its active returns are related to overall portfolio active returns.
contribute more to a portfolio’s active variance
(1) it has a higher active weight
(2) its active returns are related to overall portfolio active returns.
Practical considerations when considering the appropriate level of portfolio risk
(1) Implementation constraints -> limit the manager’s ability to under/ overweight
(2) Limited diversification: higher risk/return targets -> run out of high-return investment opportunities and lose the ability to diversify efficiently -> reduce Sharpe ratio
(3) Leverage and its implications for risk: too much leverage reduce expected compound return
classification of risk constraint
(1) heuristic risk constraint
(2) Formal risk constraint
Heuristic risk constraint
- Definition
- Example
(1) Definition: based on experience or general ideas of good practice
(2) Eg:
- Limits on exposure to
+ individual positions,
+ sectors or
+ regions,
- Limits on leverage
- Measures designed to control the degree of illiquidity and turnover in the portfolio
Formal risk constraint
- Definition
- Example
(1) often statistical in nature.
A key distinction between formal and heuristic risk measures is that formal risk measures require forecasts of
return distributions, which introduces estimation error.
(2) Eg: limits on
+ volatility,
+ active risk,
+ skewness,
+ drawdowns
+ VaR
turnover ratio
= the lesser of purchases or sales / average monthly net assets.
slippage cost
+ similar to trading cost
+) = execution price - 1/2(Bid+ask) arrival price
+) 4 conclusions:
(1) more important than commission costs
(2) greater for smaller-cap securities than for large-cap securities
(3) are not necessarily greater in emerging markets.
(4) can vary substantially over time, especially when market volatility is higher
Drawback of Hedge portfolio strategies
(1) non linear relationship factor return vs portfolio return
(2) Midle percentile is not utilied
(3) concentrade
(4) Not pure factor, may correlate to other factor
(5) other drawback related to short position
Hedge portoflio definition
long top percentile by rewards factors, short bottom percentile
