Reading 27: Equity Portfolio Management

Question 1

“discuss the role of equities in the overall portfolio”

Answer 1

• Inflation hedging
• Long term real returns are higher than bonds
• Long term returns add to the growth of the portfolio

Question 2

“discuss the rationales for passive, active, and semiactive (enhanced index) equity investment approaches and distinguish among those approaches with respect to expected active return and tracking risk”

“recommend an equity investment approach when given an investor’s investment policy statement and beliefs concerning market efficiency”

Answer 2

Passive/Active/Enhanced
Does not reflect investment expectation through changes in security holding/Identifying the stocks that will perform better than the index/tends to build a portfolio that will have limited volatility around the benchmarks return
Equity markets are efficient/Equity markets are inefficient/Extract information not embedded in the stock prices in a limited way.
Active return:
0%/2%+/1%-2%
Tracking risk:

Question 3

“distinguish among the predominant weighting schemes used in the construction of major equity share indices and evaluate the biases of each”

Answer 3

Price Weighted/Value weighted/Equal weighted
Price Weighted: Each stock is weighed according to its absolute price.
Value Weighted: Each stock is weighed according to its market cap.
Sub type: free float adjusted market cap index - concerned with the investable market values of equity issue.
Equal weighted: Each stock is weighted equally.
Biases:
Highest priced shares/Companies with larger market capitalisation/Small company bias
Advantages:
Simplicity of construction, go back in the past