class 4: equity management Flashcards
what does an equity analyst do?
does a lot of research on companies and valuate them
–> they recommend whether portfolio manager should buy or sell the shares
what does an equity portfolio manager do?
he looks at the equity analyst recommendations and he chooses the asset allocation, and security selection
roles of equity in a portfolio
capital appreciation
dividend income
diversification with other asset classes
hedge against inflation
investment process
- understanding the client + IPS
- asset allocation
–> gotta make a call about markets
- security selection
- portfolio execution
- perfomance evaluation
equity portfolio: size and style
size = what kind of companies we want to buy (large, medium, small)
style = value investing, or growth investing, or a blend of both
the safest companies to invest
large companies because they are stable and pay gyu dividends
do small companies pay dividends?
nah boy
why should we care about style and size
- client’s needs, risk tolerance, and return needs
- diversification benefits
- construct relevant benchmark
- analyze how firm characteristics change
- overall portfolio risk
disadvantage od using the size and style matrix
companies switch categories over time
equity P fees and costs
- Management fees based on % of assets managed
- performance fees: 10 - 20% based on appreciation threshold return/high-water mark
- administration fees
- trading costs
5.
what do we do after asset allocation?
which choose our investment strategy
–> Passive or active
passive strategy
trying to follow the equity market index or benchmark
–> ETF
active strategy
seeking to outperform the benchmark and add value
market segment (passive stagey)
broad vs focused
domestic vs international
developed, emerging, or frontier
capitalization
size facture
large cap
mid cap
small cap
choosing an index (passive strategy)
market segment
capitalization
growth value vs. (***)
other risks
capitalization weighted index
(total market cap at 1) / total market cap at 0)
a way to measure performance
–> the best one to use because there won’t be anything misleading
price weighted index
each company’s stock is weighted by its price per share, and the index is an average of the share prices of all the companies
find the sum of the share prices of the individual companies, and divide by the number of companies
–> In some averages, this divisor is adjusted in order to maintain continuity in the event of stock splits or changes to the list of companies included in the index
a way to measure performance
equal weighted index
we find the arithmetic average HPR for the period and add it to the initial index value of 100
a way to measure performance
–> worst one to use because can give there are a bunch of misleading
down jones uses which performance measure
price weighted index
S&P uses which performance measure
capitalization weighted index
why do we use the Dow jones to measure stock performances instead of S&P?
because it is one of the oldest ones
how to build a passive portfolio
pooled investments: open end mutual funds
–> rattiest
ETFs
derivatives-based
–> riskiest
portfolio construction methods
- full replication
–> closely matches index return
- stratified sampling
- optimization
- blended approach
disadvantages of the full replication portfolio construction method
transaction costs
regular reconstitution and rebalancing required
stratified sampling portfolio construction method
initially less costly than full replication as only a subset of all stocks is used
sampling could be base don dimensions such as industry style, or country
we don’t need to buy as many stocks so we save on commission and time
optimization portfolio construction method***
lower tracking error
explicitly consider covariance between constituent stocks
Portfolio optimization is the process of selecting the best portfolio (asset distribution), out of the set of all portfolios being considered, according to some objective
–> The objective typically maximizes factors such as expected return, and minimizes costs like financial risk.
blended approach portfolio construction method
full replication best if small number or liquid stocks
stratified sampling or optimization best if large number of stocks or illiquid stocks
large indexes that have all of the above characteristics could use a combination of approaches
tracking error
difference between our portfolio return and the index return
tracking error causes
management fees
sampled portfolios vs replicated portfolios
index based and end-of-day stock prices
brokerage commissions
cash drag
currency exchanges
cash drag
cash held for redemptions. dividends, and sale proceeds
–> does not earn a return
ongoing adjustments of choosing a benchmark
rebalancing
reconstitution
rebalancing when choosing our benchmark
updating constituent stock weights to reflect changes in market cap
ex: when equities go up, they have a higher proportion in our portfolio, so we have to sell some to keep our initial asset allocation
reconstitution
removing and replacing constituent stocks that no longer fit the index market exposure
ex: small cap becomes mid-cap
why does a company want to be par tof an index?
all of passive managers will have no choice but to buy it
what if don’t choose companies but we choose factors
factor investing***
involves targeting quantifiable firm characteristics or “factors” that can explain differences in stock returns
The approach is quantitative and based on observable data, such as stock prices and financial information, rather than on opinion or speculation
risk factors in factor investing
growth factor: high P/E, high P/B
value factor: low P/E, low P/B
size factor:
yield factor
momentum factor:
quality factor:
volatility factor:
smart beta
defines a set of investment strategies that emphasize the use of alternative index construction rules to traditional market capitalization-based indices
emphasizes capturing investment factors or market inefficiencies in a rules-based and transparent way
Smart beta investment portfolios offer the benefits of passive strategies combined with some of the advantages of active ones, placing it at the intersection of efficient-market hypothesis and factor investing
advantage to passive factor based strategies
less costly than active management
still allows factor exposure based on market view
disadvantage of passive factor based strategies
higher management fees and trading commissions
7 strategies for active investing strategies
- fundamental
- quantitative
- top down
bottum uo
factor based
activism
other
fundamental
use research, skill, and experience to estimate intrinsic value of securities
–> subjective
larger positions and fewer holdings
higher manager conviction ideas receive higher eight
continuous monitoring and rebalancing
risk if misestimated intrinsic value or market fails to recognize misplacing
- fundamental investment process (check screenshot)
define investment universe in accordance with fund mandate
prescreen universe to obtain a manageable set of sucritirw
- top down strategies
focus on overall macro and broad market variables
matters can use ends and derivatives to overweight best markets and underweights worst markets
- -> according to
1. country/geography
- industry/sector
- volatility
- thematic investment strategies
- bottom-up
value based approaches
growth based approaches
value based approaches
identify securities trading below estimated intrinsic values
we pick the best companies of the best
–> we don’t worry about the economy
growth based approaches***
check google
factor based strategies
a factor is a variable or characteristic with which asset returns are correlated
reward factors have positive association with long term positive risk premiums
managers must avoid unrewarded factors that don’t over persistent returns
implementing factor based portfolios
hedged portfolio approaches
the factors (check screenshot)
size
value
price momentum
growth
quality
unstructured data
factor timing
equity style rotation
could investigate market condition that lead to factor outperformance
equity style rotation
check google
activist strategies
specialize in taking stakes win companies and pushing for change to enhance value
identifying opportunities, buying stake in public company, submitting proposal for change, threatening and launching a proxy contest for …
sattistical arbitrage
pairs trading: long7sgort two securities that have historically had a high correlation but have deviated from this long-term relationship
–>
market microstructure-based arbitrage
imbalances between buy/sell orders may trigger temporary (milliseconds9spikes in the market
even driven
exploit market inefficiencies around corporate events
–> ex: during merger/acquisition involving share of share exchange
active investing, portfolio construction process
3 main building blocks
overweight, underweight reward factors
alpha skills (identifying mispricings)
position sizing (confidence in Alpha and factor insights vs concentration risks)
market neutral approach (active stagey)
remove market exposure with long and short exposures
target beta of 0
long-only vs long/short investing
influenced by long term risk premiums (could be negative)
capacity and scalability (short tselling requires borrowing)
limited legal liability (higher risk for long/short)
regulation (some countries ban it)
transaction complexity (higher for long/short)
costs (higher for long/short
personal ideology (some investors object to it)
