MIP Ch 7: Equity Portfolio Management Flashcards
Name three different index weighting choices.
Price weighted - weight by share price
Value weighted - weight by market capitalization
Equal weighted - equal weights for each stock
Name the two different techniques for identifying investment styles
Returns-based Style Analysis
Holdings-based Style Analysis
State the four choices that determine a stock index’s characteristics
- Boundaries of the stock index’s universe
Determines how well the index represents a group of stocks - Criteria for inclusion in the index
- How the stocks are weighted
Usually price weighting, value weighting, or equal weighting - How returns are calculated
Price only or total return (including dividends)
What are the reasons there may be more price inefficiency on the short side?
Many investors only look for undervalued stocks, not overvalued ones
But short selling can be difficult when many investors are competing to borrow the
same shares
Stocks could be overvalued due to management fraud, creative accounting, or
negligence
Analysts usually have more buy recommendations than sell recommendations
Creates more trading, which means more commissions
Analysts are reluctant to issue negative opinions because often own a stake in the
company
Describe socially responsible investing (SRI).
Also called ethical investing
Devoted to the conscious creation of social impact through investment
Consider ethical values and societal concerns when making investment decisions
SRI commonly uses stock screens (positive and negative)
For example, may choose to exclude tobacco and gambling firms
State the limitations of semiactive stock-selection
Any technique that generates a positive alpha will likely become obsolete
Models that worked historically may not work in the future
Shocks to the market could change everything
State the fundamental law of active management.
IR IC
?
Breadth
What are two key concerns for socially responsible investing (SRI)?
Could have increased concentration risk and less diversification
State the five main categories of topics that should be included in an equity manager
questionnaire (according to MIP Ch 7)
- Organization/People
- Philosophy/Process
- Resources
- Performance
- Fees
What are the three sub-styles of value-oriented investing?
Low P/E
Contrarian
High dividend yield
State the three main kinds of passive investment vehicles mentioned in MIP Ch 7.
- Indexed Portfolios
- Equity Index Futures
- Equity Total Return Swaps
State the advantages of equity indexing.
Lower management expenses
Lower trading costs
Lower portfolio turnover
Lower tracking error
Higher tax efficiency
A logical way to gain exposure to market with which an investor may be unfamiliar
(e.g. overseas markets)
Typically better informational efficiencies
Passive indexing has outperformed active management based on historical
returns net of fees
How is the information ratio calculated?
The information ratio is the mean active return divided by the tracking risk
What are the two growth investment sub-styles?
Consistent growth
Earnings momentum
What are the three main approaches to equity investment?
- Passive Management
Indexing is the dominant form of this strategy
The portfolio must be continuously adjusted to match the index - Active Management
Attempt to outperform an index
The active return is the portfolio return less the benchmark
Tracking risk is the annualized standard deviation of active returns
The information ratio is the mean active return divided by the tracking risk - Semiactive Management
This is also called enhanced indexing or risk-controlled active management
State the advantages of returns-based style analysis.
Characterizes entire portfolio
Facilitates comparisons of portfolios
Aggregates the effect of the investment process
Different models usually give similar results
Clear theoretical basis
Requires minimal information
Can be executed quickly
Cost effective
State the disadvantages of returns-based style analysis.
May be ineffective in characterizing current style
Error in specifying indices in model may invalidate results
State the advantages of holdings-based style analysis.
Characterizes each position
Facilitates comparisons of individual positions
May capture style changes more quickly
State the disadvantages of holdings-based style analysis.
Not consistent with how portfolio managers select securities
Different specifications will lead to different results
More data intensive
State the disadvantages for value-oriented investing.
The stock may be cheap for a reason the manager does not know
Even if the security is not properly valued, the holding period may not capture
when the price correction occurs
Trigger events may be required for price changes
Investors often confuse cheap with a large liquidity premium
Note: The bottom line is that an investor needs to make sure they understand why
they think the stock is a value. If they are wrong, then the strategy obviously may
not work
Define alpha.
Alpha is the portfolio’s return in excess of that on a risk-matched benchmark
Measures the amount of active return
Describe the two categories of selling disciplines.
- Substitution strategy
Replace an existing holding when a better opportunity is available
Reasons include opportunity cost and deteriorating fundamentals - Rule driven strategy
Includes value-level, down-from-up, up-from-cost, and target price sell disciplines
A value investor may sell a stock of the P/E ratio rises to a certain level
Could determine to sell a stock if the price drops x% from the purchase price
(down-from-cost)
Should analyze the after-tax effect
Describe four reasons why investors are more risk averse when facing active risk vs.
total risk
- Must assume successful active management is possible and the managers have
the necessary skill - Many active managers fail to beat the benchmark / underperform
- Superiors will judge how well the overall portfolio performs relative to benchmarks
- As one moves up on the efficient frontier assuming more active risk, less manager
diversification exists
Describe the core satellite approach.
In the overall portfolio, could have core holdings of an index and semiactive
managers
Anchor an index portfolio and use active managers around the anchor to achieve
an acceptable level of active return
The active managers represent the ring of satellites
The goal is to add active return (alpha) through the satellites
Want an acceptable level of active return without too much active risk
Describe a completeness fund.
A completeness fund makes the overall portfolio, active and passive
components, have the same risk exposure as the investor’s overall equity
benchmark
Must be adjusted periodically as the actively managed accounts change
Describe the shortcomings of alpha-beta separation.
Shorting may not be allowed for some investors/institutions
Systematic risk may remain
Describe portable alpha strategies.
Portable alpha is a strategy involving the combination of multiple positions (e.g.
long and short positions) so as to separate the alpha (unsystematic risk) from
beta (systematic, market risk) in an investment.
Portable alpha means that alpha is available to be added to a variety of
systematic risk exposures.
Describe alpha-beta separation.
Have both long and short positions that have offsetting beta so that the portfolio
beta is zero. Long the position with greater alpha to get a portfolio with beta close
to 0 but positive alpha
Alpha
Unsystematic Risk = Value Added by the Portfolio Manager = Return in excess of a
risk-matched benchmark
Beta
Exposure to systematic, market-level risk
