Active equity portfolio management Flashcards
Four main building blocks of portfolio construction
- Weights on rewarded factors: Market, sizes, value, and momentum) 2. Alpha Skills: Timing factors, securities, and markets 3. Sizing positions 4. Breadth of expertise
Combination of approaches
- Systematic vs discretionary Systematic strategies incorporate research-based rules across a broad universe of securities Discretionary strategies integrate the judgment of the manager on a smaller subset of securities Bottom-up vs. top-down
Combination of factor exposure and risk affects active share and risks.
Benchmark agnostic
Have a greater level of Active Share and active risk
Risk Constraints can be formal or heuristic
Heuristic constraints
- conscentration by security, sector, industry, or geography
- net exposure to risk factors, such as Beta, size, value, and momentum
- net exposures to currencies
- the degree of leverage
- the degree of illiquidity
- exposures to ESG factors
- Other investors concerns
Formal risks
- Volatility - standard deviation of portfolio returns
- Active risk - aka tracking errors
- Skewness - return expectations are non normally distributed
- Drawdown - portfolio loss from its high point until it begins to recover
- Value at risk (VaR) - the minimum loss that would be expected a certain % of a portfolio
- CVaR - the average loss that would be incurred if the VaR cutoff is exceeded
- IVaR - the change in portfolio VaR when adding a new position to a portfolio
- MVaR (Marginal)- the effect on portfolio risk of a change in the position size.
The cost of managing assets
- Slippage costs are significantly greater for smaller-cap securities and during periods of high volatility
- Immediate execution will incur higher market impact cost
- Migigate market impact costs by slowly building up positions as liquidity becomes available but may incur higher volatility/trend price risk
Fundamental Law Formulae
What is Active Share
Active Share: which number and sizing positions in a manager’s portfolio differ from the benchmark. If a portfolio has an active share of 0.5, meaning 50% of the allocation positions of the portfolio equals the benchmark.
Sources of Active Share
- Including securities in the portfolio that are not in the benchmark
- holding securities in the portfolio that are in the benchmark but at weights different from the benchmark
Difference between Active Share and Active Risk
Active Share is not concerned with the efficiency of diversification; Active risk is affected by the degree of correlation
Active risk increases when a portfolio becomes more uncorrelated with its benchmark.
Underweighting and overwriting is the same in the bank/bank over-/underweights and in the bank/tech over-/underweight. THe active share is the same. Since correlation of the bank/tech pair is lower than the bank/bank in the benchmark, the active risk will increase
Multi-factor portfolio characters (active risk, active share)
low concentration on securities (>250 positions); balanced exposure
Diversified across factors and securities
high active share
low active risk
Concentrated stock picker (active share, active risk)
High active share
High active risk
a higher level of idiosyncratic risk
fewer holdings (100 stocks)
sector rotator
high active risk
may have higher active share if concentrated
may have lower active share if diversified
Well constructed portfolio exhibits
- a clear investment philosophy and a consistent investment process
- risk and structural characteristics promised by the investors
- risk-efficient delivery methodology
- low operating cost
Preference of portfolio
- Low idiosyncratic risk
- low absolute volatility and low active risk
- higher active share
Long short portfolio construction
calculate the total portfolio variance contributed by asset 2
the portion of total portfolio risk that is explained by market factor in Fund 1’s existing portfolio
