Equity 22-25 Flashcards
equity in overall portfolio
- capital appreciation
- dividend income
- diversification with other asset classes
- hedging against inflation
- client considerations for equities in a portfolio
negative screening
exclusions screening
positive screening best-in-class screening
thematic investing
screens equity based on a specific theme
-impact investing related approach that seeks to achieve targeted social or environment objectives, along with measurable financial returns through engagement with a company or buy direct investment in projects or companies
segmentation by size and style
adv:
1. reflects risk, return and income characteristics clearly
2. diversify by investing across sectors
3. easier to construct a bak by type
4. allows a portfolio to reflect a firm’s maturity and potentially changing orientation
disadvantage:
1. the categories may change over time and maybe defined differently among investors
segmentation by Geography
based on stage of market’s macroeconomic, development and wealth
DM, EM, frontier mkt
adv: easier to diversify disadvantage: 1. may provide lower-than-expected exposure to that market 2. presence of currency risk
weakness:
targeting large companies domiciled in developed countries, the actual exposure to a specific geographic market may be lower than expected
segmentation by economic activity
industries/sector:
production oriented or market oriented approach
production oriented: group companies that produce similar products or use similar inputs
market oriented: group companies based on their target market, the way revenue is earned and the way customers use companies’ product
adv:
1. allow portfolio managers to analyze,conpare, and construct performance benchmark based on specific sectors/industries
2. diversification benefits are enhanced when investment span across different sector/industries
disadvantage:
not easily assigned to any sectors/industries
risk reduction through diversification is likely to be less than expected:
- the correlation are likely to move towards 1.0
2. the volatility of the assets is likely to increase
dividend income
- consider taxation
- cash dividend, stock dividend, optional dividend
- regular dividend and special dividend
Securities lending income
a form of collateralized lending
- can facilitate short sale
- stock lending: security transfer transaction stock loan 0.2-0.5% fee
generate further income by reinvesting the cash collateral received
transfer voting rights
ancillcing investment strategies 附属的
additional income generated from trading strategy
- dividend capture purchase stocks just before ex-dividend date and sell subsequently
- writing options, covered call, cash-covered/secured pmt
fees/costs
- mgmt fees
- performance fees, high water-mark fee threshold
- administration fees (Processing corp. action, rights issue)
- external fees (custody, registration)
- marketing & distribution cost
- trading cost (explicit & implicit)
Shareholder engagement
actively interact with companies on:
- strategy
- allocation of capital
- corp. governance and regulatory & political risk
- remuneration (compensation of directors, senior mgmt)
- composition of BOD
Benefit from companies perspective:
- can assist in developing a more effective corp. governance culture, better company performance
- free rider
- other stakeholders may benefit from the active mgmt
-
disadvantage:
- timing consuming and costly to both shareholder and companies
- pressure on company mgmt to meet near-term share price or earnings target could be made at the expense of LT corp. decisions
- potential conflict of interest
- potential insider trading
active management rational:
confidence, client preference, suitable benchmark (sufficient liquidity) mandate
risk: reputation risk
key person
taxes: higher portfolio turnover lead to higher tax burden
Empirical evidence suggest equity provide LTD protection against inflation.
equity is a claim on real earnings, however doesn’t hold all the time.
in ST and inflationary environment, often do not provide a hedge and have native correlation with inflation.
passive equity investing
adv:
- low cost
- broad diversification
- tax efficiencies
- rule-based
- transparent and investable strategy that does not involving identifying imispriced individual securities
- can include investing in a change set of market segments that are selected by pM
MOTIVATION:
- COST OF PASSIVE < cost of active
- asset allocation > security selection (does not justify cost)
- efficient market hypothesis hold, stock price incorporate all relevant info
- lower fee
- seek to take an index, achieve beta return not alpha (outperformance)
buffering:
packeting
can be used to smooth stock migration between indexes and improve the investability of an equity index.
buffering:
involves establishing ranges around breakpoint that define whether a stock belongs in one index or another
packeting: involves splitting stock position into multiple parts
(60% large cap, rest in mid-cap)
constraints when choosing a bmk
1. exposure capitalization style exposure factor
- risk-factor exposure
index construction methodologies
- exhaustive (select every constituent of a universe)
-selective (target only those securities with certain characteristics)
market weighted
market cap weighted index based on efficient market hypothesis, low cost
adv:
- reflect a strategy’s capacity, can be thought of as liquidity weighted
- a reasonable proxy for the market portfolio, the tracking portfolio maybe close to mean-variance efficient
most common form- free-float weighting
reflect actual liquidity
- adjust each consitunent’s shares outstanding for closely held shares that are not generally available to the investing public
- can be comped since the index provider have to reach out to the firm’s shareholder securities unit or to rely on analytical judgements
price-weighted index
wi = share price/ sum of all share prices
interpret as a portfolio that consists of one/same share of each constituent company
disadvantage:
- when stock split, calculations become complex
- assumption that the same # of shares each is held in each company stock is a shortcoming
equal-weighted index
naive strategy
=1/#shares in the index
adv:
- produce the least concentrated portfolio, result in reduction of style stock concentration risk and slow changing sector exposure
- factor-indifferent, and the weighting randomize the misplacing
disadvantage:
- produce higher volatility than cap weighted, deviate from market weight most dramatically for large-cap indexes
- require frequent rebalancing
- limited investment capacity
- in case that any of the constituent stocks are misplaced, it will experience return superiority as the stock prices move up and down toward their correct value.
fundamental weighted index
philosophy:
- it’s weighted based on such attributes as a stock’s fundamental characteritics
- market price will eventually converge to a level implied by fundamental attributes
HHI= weight ^2 # of stock =
1/ HHI
as HHI increase, concentration risk decrease
Defensive or volatility ready strategies
- income oriented investor
dividend yield - volatility weighting calculates the volatility of each constituent stock and weights the index based on the inverse of each stock’s relative volatility
minimum variance index using mean-variance optimization
period rebalancing & reconstitution
reconstitution - add/delete of index constituents
rebalance - reweighing of constituents
factor based strategies
size value
quality
momentum
- smart beta
can be used to place of or to complement a market cap-weighted index portfolio - concentrate on risk exposures
- transparent in factor selection, weighting & rebalancing
- higher mgmt fees
- trading commission more than market-cap indexes
0provide pure exposure to specific market segments (fact rotation)
return-oriented
dividend-yield strategy
momentum strategies
fundamental weighted strategies
risk oriented
seek to reduce downside volatility and overall portfolio risk
using std of price return for the past 252 trading days
- volatility weighting
- minimum variance investing, requires access a mean-variance optimizer
adv:
simple to understand and provide a way to reduce absolute volatility & downside returns
disadvantage:
- based on past returns, may not reflect futures
-investor will not always achieve their objectives
disadvantage:
- less accurate than holdings because they do no t utilize actual portfolio holdings
- most return-based models impose unnecessary constraints that make it difficult to detect more aggressive positions such as deep value or micro-cap
diversification oriented
include equally weighted indexes and maximum diversification strategies
approaches to passive equity investing
pooled investment
most convenient
open ended mutual fund/ ETF
mutual fund: as of purchase
low cost
convenient of fund structure
ETFs: ease of trading
low mgmt fee
tax efficiency
may in short borrowing position
disadvantage:
transaction cost from commission and bid-ask spread liquidity ETF secondary market
Derivative-based approach
- low cost, easy to implement, provide leverage
- however present risk such as counterparts default risk for derivatives that are not traded on exchanges
- difficult to access by investors
- not used for passive, but are used to adjust pre-existing portfolio to move closer to meeting objectives (overlay)
completion overly
address an indexed portfolio that has diverged from its proper exposure
rebalancing overlay
address a portfolio’s need to sell certain constituent securities and buy others
currency overlay
assists a portfolio manager in hedging the returns of securities that are held in a foreign currency back to the home country’s currency
advantages of using equity index derivations
options/ futures, swaps over cash-based techniques
adv:
- can be used to quickly adjust factor exposure at low costs
- trade in liquid market
- marke it easy to average the portfolio
disadvantage:
- basis risk increase tracking error
- some contracts have position limits
- OTC derivatives introduce counterpart risk
- market to market: small change in index value can result in margin call
- they must be rolled, out/or near expiration
full replication
adv:
- matching index performance
- easy to comprehend
disadvantage:
- requires that asset size of the mandate is sufficient
- index constituents are available for trading
stratified sampling
subset based on key risk
- higher tracking error
- limited postion/size
- liquidity
dealing with small asset
to stratify is to arrange a population into distinct subgrouping
arranged correctly, the various strata will be mutually exclusive and also exhaustive and they should closely match the characteristics and performance of the index.
optimization
use covariance
involve maximizing a desirable characteristic or minimizing an undesirable characteristics, subject to one more more constraints using computed algorithm
adv:
a lower amount of tracking error than stratified sampling
- accounts explicitly for covariance amount the portfolio constituents
disadvantage:
- the constituents and weights of a such portfolio is determined based on past market data
- the optimization need to be run frequently which is costly
tracking error
indicate how closely the portfolio behaves like its benchmark and measure a manager’s obligation to replicate the benchmark return
= square root of variance rb
potential causes
- fees charged
higher fees, lower excess return, lower tracking error
- # of securities held by the portfolio vs. the benchmark
- intra-day trading of the constituent stocks of an index portflio also presents an important issue to consider such attributing tracking error
- cash drag
- producing TE involves a trade off between higher trading cost of full replication and the increase potential for tracking error that comes withs sampling
excess return
rp-rb
securities lending
credit collateral market risk
proxy voting
investor activism
increase options, better manage risk or provide better broad oversight and corp. governance
return to index stock increase
fundamental
subjective discretionary human skill, judgment research conviction in stock, sector, region forecast future corp. parameters and establish view use judgment and conviction with risk parameters rebalance bottom up, top-down value/growth intrinsic/relative value
prescreen to identify potential investment
perform in-depth analysis
determine buy/see
allocation asset by determine industry/country/ region exposure
set limits or max selection country, individual stock position
determine by/see list
monitor portfolio holdings continuously
bottom up strategies
begin the asset selection process with data at the individual asset and company level, such as prices momentum and profitbility
value-based approaches
aim to buy stocks that are trading at a significant discount to their estimated intrisinc value
