Section 3 - Equity PM Flashcards
Functions of Equity PM
- Capital Appreciation
- Dividend Income
- Diversification
- Hedge Against Inflation (e.g. Commodities)
Client Considerations
- Growth
- Income
- Factor Exposure (Inflation, Rates etc)
ESG Considerations in Equity PM
- Negative Screening (Exclude)
- Positive Screening (Include)
- Thematic Investing (Energy Efficiency)
- Impact Investing (Targeted Objectives)
Segmentation of Equity PM
- Investment Type: Value, Core, Growth
- Company Size: Small, Mid and Large Cap
- Geography
- Economic Activity (Industries & Sectors)
Sources of Income (Equity PM)
- Dividends
- Securities Lending (Aluguel)
- Ancillary Investment Strategies (Comprar Equity antes de Ex-Dividend, Covered Calls e Cash Covered Puts)
Sources of Fees in Equity PM
- Management Fee (over AUM)
- Performance Fees (subject to Hurdle, Water Marks, Clawbacks)
- Adm Fees
- Marketing & Distribution Costs
- Trading Costs (Explicit as Fees and Implicits as Bid-Offer and Delay Costs)
Passive Equity PM Advantages
- Low cost
- Broad diversification
- Tax Efficient
Equity Benchmark Selection Rules
- Rules Based
- Transparency and Disclosure
- Investable
Buffering (Concept)
Create ranges between breakpoints to determine if asset is mid or large cap.
Increases the effective numer of stocks hold in a portfolio (?)
Packeting (Concept)
Split a stock between two parts put each part into its respective budget
Ex: 50% da posição cheia de AMER3 consta no peso reservado a Small Caps no Portfolio e 50% em Distressed Assets
Reduces turnover
Reduce trading costs
Index Types
- Market Cap Weighted: Mean-Variance is Optimal
- Equal Weight: Less Concentrated in some Stocks
- Factor-Based: Growth, Size, Momentum, Value, Yield
Equity Portfolio Strategies (Types)
- Return-Oriented (relative, absolute)
- Risk-Oriented
- Diversification-Oriented (e.g. No Single Stocks)
Equity Porfolio Asset Options
- Pooled Investments: Mutual Funds, ETFs
- Derivatives: Options
Includes Basis Risk (Future Price ≠ Spot Price) and Counterparty Risk (if OTC)
- Separately Managed Accounts: Portfolios Exclusivos
Tracking Error (Formula)
TE = √Var(Rp-Rb) caused by fees, # of constituents, trading intraday, cash drag
HHI (Formula)
HHI = ∑ wi²
Effective # Stocks = 1 / HHI
Value Active Strategies (List)
Relative: Peers
Contrarian: Oposto do sentimento de mercado
High Quality: Intrinsic Value + Signs of Financial Strength (ITUB)
Income Investing: Dividend focused
Deep Value: Finding extremely low valuations for good assets
Restructuring: AMER3
Special Situations: Outras reestruturações (operacional, por ex)
Growth Active Strategies (Example)
STNE US
PAGS US
Active Strategies (List)
- Value
- Growth
- Top Down
- Bottom Up
- Activist Strategies
Fundamentalist Building Portfolio (What to Do)
- Pre-Screening
- OW Outperformers and/or
- UW Underperformers
Quantitative Building Portfolio (What to Do)
Maximizes Function (Risk / Return)
Active Equity Investing Process (List)
- Define Universe
- Prescreen
- Understand
- Forecast Company Performance
- Build Portfolio
- Rebalance
Active Equity Investing Pitfalls (List)
- Biases
a. Behavior Bias: Cognitive and Emotional
b. Confirmation Bias: Searches information to confirm previous feeling
c. Illusion of control: Overestimate your own ability
d. Availability Bias: Mental Shortcuts to estimate the probability of an outcome based only in available information and how easily it comes to mind
e. Loss Aversion
f. Overconfidence Bias
- Value Trap: Low P/E for AMER3 may become even lower
- Growth Trap: Getnet split to unlock value
Quantitative Investing Process (List)
- Define investment thesis
- Acquire data and process
- Backtest (Info Coefficient - Pearson / Spearman)
- Evaluate (Out-of-The-Sample test)
Pitfalls: Survivorship Bias, Look-Ahead Bias, Data Mining, Turnover
Issues: Risk Models, Trading Costs
Quant Pearson Information Coefficient (Concept)
Pearson IC = Correlation (Factor; Period Return t+1)
High = Good
Disadvantage: Sensitive to outliers
Quant Spearman Information Coefficient
Correlation (Factor Score Rank; Stock Return Rank t+1)
Advantage: Better predictor due to lower sensitive to outliers
Factor Based Strategies (List)
- Value: Low P/E, High E/P, Low P/B (Higher Premium on Risk of Financial Distress)
- Price Momentum: Carry of 12 months Return
- Growth: Stone & Pags
- Quality: Earnings Quality, Profitability, Solvency, Analyst Sentiment
- Unconventional: Satellite
- Activist: Board Nominations, Engage with Letters, Propose significant changes in General Meetings, Reduce Management Compensation, Launch Legal Proceedings, Breakup a Conglomerate to Unlock Value
Factor Activist Strategy Targeted Companies (Concept)
Targets: Companies with Low Revenues, Negative Price Momentum, Weaker Corporate Governance
Factor Statistical Arbitrage Strategy (Description)
Use statiscal and technical analysis to exploit pricing anomalies.
- Traditional
- Time-series with econometric models
- Machine-Learning techniques
Ex: Pairs Trading, Market Microstructure
Sources of Active Return (List)
- Exposure to rewarded factors
- Alpha
- Luck
Blocks for Portfolio Construction (List)
- Factor Weightings: OW/UW relative to benchmark
- Alpha Skills: Exposure to unknown factors or Timing of Known Rewarded Factors
- Position Sizing:
a. Factor Orientation: Target Specific Exposure to Factors + Keep Diversification
b. Stock-Picker: Confia no αlpha
Concentrated portfolio assuming high level of idiosyncratic risk
Breadth of Experience (Formula)
E(Ra) = IC * √BR * σRa * TC, where
E(Ra) = Expected Active Return
IC = Information Coefficient
√BR = # Independent Decisions Each Year
Ra = Std Dev of Active Return
TC = Transfer Coefficient
Active Share (Concept and Sources)
Measures the extent to which number & sizing positions differ from benchmark
Sources:
1. Hold diferent weights
2. Hold different securities (100% different weight)
Active Share (Formula)
Active Share = 1/2∑ |WPortfolio - WBench|
WEIGHTS
Active Risk (Concept)
Tracking Error = √Var(Rp-Rb)
Increases with:
- Cash
-New Assets w/ High Covariance versus Portfolio
Decreases with:
- Diversification
- Low correlation between assets
STANDARD DEVIATION OF RETURNS
Sources of Passive Return (List)
- Attribution analysis (choosing assets)
- Securities Lending
- Activism
Portfolio Construction Process (Fundamental v. Quantitative)
Fundamental: Judgmental @ stock level
Quantitative: Use optimizers @ portfolio level
Active Strategies: Bottom-up and Top Down (List)
Bottom-Up:
a. Value-Based: Contrarian Investing, High Quality, Income Investing, Deep Value, Special Situations
b. Growth Based Approaches: Hybrids between Growth and Value. Rely on PEG and less worried on expensive P/Es, EV/EBITDA and P/Bs.
Top-Down:
a. Country, Geographic
b. Sector, Industry Rotation (OK to bottom-up as well)
c. Volatility Based Strategies (Derivatives Long/Short Vol)
d. Thematic (Macro, Demographics, Disruptive Tech)
Hedged Approach (Factor Based Strategy Concept)
- Choose factor
- Divide stocks in quantiles
- Long the Best and Short the Worse
Drawbacks:
a. Ignores intermediate quantiles
b. Assumes linear factor v. return relationship
c. Tends to be concentrated
d. Requires shorting stocks
e. Not a pure factor strategies (comes with other risks)
Sector Neutralization Strategy (Concept)
- For Momentum Strategies, long best and short worse may imply sector bets
- If you do not want to bet in an industry, neutralize sectors and keep momentum factor only
Event-Driven Strategies (Concept)
M&As, Earnings Event, Restructuring
Investment Styles per Type
- Characteristics Based: Value, Growth, Capitalization, Volatility
- Membership Based: Sector, Country, Market
- Positions: Long/Short
Style Classification Approaches (List and Limitations)
- Holdings-Based: Value, Growth, Size. Requires discretionary specifications. More accurate than 2.
Limitations 1: Requer abertura de todos os constituintes do portfolio
- Returns-Based: Comparation between Portfolio and Bench Style XPTO. Multivariate Regression against various indexes. More widely applied.
Y = a + b1x1 +b2x2 + error where b1 and b2 are excludent
Here, R² = Index and
(1-R²) = Selection
- Manager Self-Identification: Discretionary Mandate
