Lecture 9 - Equity Portfolio Management

Question 1

Passive equity management is considered a…

Answer 1

Long term buy and hold strategy.

Question 2

It is necessary to…

Answer 2

Rebalance the portfolio as the composition of the benchmark changes and cash distributions must be reinvested.

Question 3

Passive equity management is low cost but not…

Answer 3

Costless (transaction costs).

Question 4

Index Portfolio Construction Techniques - Full replication.

Answer 4

• All the securities in the index are purchased in proportion to their weights in the index.
• Close tracking of benchmark index; high transaction costs.

Question 5

Index Portfolio Construction Techniques - Sampling.

Answer 5

• Only buy a representative sample of stocks comprising the benchmark index. Not every stock is acquired, you can purchase small stocks so aggregate characteristics are selected.
• Low transaction costs; not close tracking.

Question 6

Index Portfolio Construction Techniques - Quadratic optimisation.

Answer 6

• Historical information (e.g. P and corr) are input to a computer program to determine the composition of a portfolio.
• Large differences if data change over time.

Question 7

Active Equity Management - Fundamental Analysis.

Answer 7

• Top-down (asset class rotation, sector rotation). Asset class rotation means that the active manager can forecast the future of different asset classes. For example, if the active manager thinks the stock market is going to be better than the bond market then they will put more money in the stock market. With sector rotation, the determinant is the sector or industry. So for example, if the active manager thinks the technology industry is gong to be better than the manufacturing industry then they will put more more money in technology industry.
• Bottom-up (stock undervaluation/overvaluation). Focuses more on security selection. If a stock is considered underpriced then buy the stock. If a stock is considered overpriced then sell the stock.

Question 8

Active Equity Management - Technical Analysis.

Answer 8

• Contrarian (overreaction, also called mean reverting). Means that the best time to buy a stock is when others think the market is most bearish. It is believed that the market is going to experience a downward trajectory. The price can go up. People are overreactive.
  Sell the stock when majority of investors in the market are bullish. This is when it is believed that stocks or any security will go up.
• Continuation (price momentum). The stocks that have been hot or have been increasing will stay hot and continue to increase. But the stocks that have been cold or decreasing will stay cold or continue to decrease (the price will).

Question 9

Active Equity Management - Factors, Attributes and Anomalies.

Answer 9

• Security characteristic factors (P/E, P/B, firm size). For example, firms with low P/E and P/B ratio and small firm size are more likely to outperform the market.
• Investment style factors (value/growth). Value stocks are more likely to outperform than growth stocks.
• Calendar effects (weekend, January). Returns on Monday are usually lower than the rest of the week. Returns in January are usually much higher than returns in other months.
• Anomalies are inconsistent evidence with the efficient market.