Managing Equity Portfolios Flashcards
What is Fundamental indexing
each stock’s index weighting is determined by four fundamental measures — not by its expected future size, as reflected in market capitalization
four fundamental measures of Fundamental Indexing
- Trailing five-year cash flow (cash flow)
- Trailing five-year sales (sales)
- Trailing five-year gross dividends (dividends)
- Book value (book)
drawback of cash flow metric
leads to over- or underexposure to highly cyclical companies.
Book Value Metric - drawback
over or underexposure to companies with aggressive or conservative accounting practices.
What is Risk Budgeting?
a process that limits the deviations of a portfolio’s return from a benchmark - used to create enhanced index portfolio.
What is Enhanced indexing?
Index-like performance with some excess return net of costs
4 steps of risk budgeting process
- Determine benchmark.
- Determine maximum acceptable tracking error.
- Identify tactical asset allocation or specific return opportunities
- Build a portfolio that deviates from the benchmark using the return opportunities identified in step three
Purpose of step 2 in risk budgeting process (determine maximum acceptable tracking error)
sets a maximum for how large of an unexpected return “surprise” the portfolio could experience.
Final purpose of risk budgeting
Maximize Portfolio’s expected excess returns without exceeding the tracking error limit determined in step two
What is the selection dimension? (Active Manager)
identify underpriced securities
What is the timing dimension (Active Manager)
anticipate general market movements
sustainable growth rate equals…
Return on equity multiplied by the retention rate.
How are enhanced active equity portfolios constructed?
by selling short undesirable smaller stocks and reinvesting the short sale proceeds into desirable long positions.
two strategies to use in market-neutral investing:
absolute return and alpha portability
what kind of strategy is long-short?
Absolute
long-short equity strategy, there are two primary sources of return.
- Return from the long position greater than short position
* T-Bill Component
long-only active investment managers try to build returns from two sources:
- exposure to systematic/market risk (beta)
* exposure to unsystematic / active risk (alpha).
A portable alpha strategy consists of three components
The beta portfolio
The alpha portfolio
The cash portfolio
three approaches to constructing an index fund
- replicating an index
- tracking an index
- fundamental indexing
With this approach, a portfolio manager constructs a subset of the benchmark that faithfully mimics an index
Index tracking
portfolio management styles fall into two categories
Active and Passsive
How does replicating an index work?
manager holds each stock in the fund’s portfolio in exact proportion to its weighting within the index.
Preferred methodology of constructing an index?
Index tracking
value fund’s objectives are (2)
income and capital preservation
difference between market-neutral management and more traditional active management (2)
• Market-neutral management eliminates the market’s effect.
• More aggressive in its stock shorting, amplifying
the approach by using leverage.
Where do proceeds of T-Bills position come from in a long short portfolio?
The short position, where the manager receives proceeds from the sale
Long short strategy return calculation
long - short + Tbill
What is portable alpha strategy?
alpha portfolio is made beta neutral by using derivatives and added to a beta portfolio
What is the purpose of portable alpha?
To enable a manager to budget risk and increase alpha without changing asset allocation mix.
alpha portfolio should be three things:
- unrelated to its underlying market
- independent of its market direction
- absolute in nature (to generate positive returns).
Difference between a managed account and a stock loan account when selling short
- in margin account, must have cash reserves on hand.
* In stock loan account, long positions serve as collateral
One way managers can use stock index futures ( + ex: )
managers dont have to sell their position and buy a position in another index. they can use futures instead.
ex: sell TSX futures and Buy SP500 Futures
example of how equity swap is used
- Portfolio manager holds position in Treasury bill
- Wants to earn return of TSX without selling position
- Enter into equity swap, where he gets return from TSX over certain period and agrees to pay T-Bill rate to counterparty
Four industry trends driving growth in ETFs:
- Growth in fee-based business
- Growth in advisors as portfolio managers
- Demand for transparency
- Broad choices and ongoing innovation in ETFs
