16042016 equity portfolio management strategies
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Equity Portfolio Management Strategies
Passive versus Active Management
Total Portfolio Return=[Expected Return] + [“Alpha”]
=[Risk-Free Rate + Risk Preiu] + [“Alpha”]
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Passive versus Active Management
Passi!e e"uit# portfolio ana$eent%u#-and-holdtrackin$ an indexatchin$ arket perforance&ana$er 'ud$ed - ho( (ell the# track the tar$et
index Acti!e e"uit# portfolio ana$eent
)utperfor a passi!e %& portfolio on a risk-
ad'usted *asis $eneratin$ “alpha”, throu$h tactical ad'ustents or securit#selection,
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An Overview of Passive Strategies
To replicate the perforance of an indexunderperfor o!erperfor the tar$et.
/tron$ rationale for this approach0osts of acti!e ana$eent
&an# arket indexes are used for trackin$ portfolios /1P %/E /ensex2 3442 5442 644 078 79FT: 9ndex2 6442 &idcap
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Index Portfolio ConstructionTechniques
Full Replication/ecurities in proportion
ensures close trackin$
↑ transaction costs di!idend rein!estent,;
Ex;
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Index Portfolio ConstructionTechniques
/aplin$ A representati!e saple of stocks
Fe(er stocks - lo(er coissions
i!idend Rein!estent less difficult7o close trackin$ > so soe trackin$ error;
Ex;
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Index Portfolio ConstructionTechniques
?uadratic )ptii@ation or pro$rain$techni"ues,
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Tracing Error and Index Portfolio Construction
Passi!e ana$er $oal
inii@e the portfolios return !olatilit#2i;e;2 to inii@e trackin$ error TE,
Trackin$ Error &easureReturn differential in tie period t
Bt =Rpt > R*t
(here Rpt= return to the ana$ed portfolio in Period t
R*t= return to the *enchark portfolio in Period t.
TE is easured as σ of Bt 2 norall# annuali@ed;
TE = CB DP P is the nu*er of return periods in a #ear2
P = 35 for onthl# return,; (here CB5=Bt > ean B,5 T-3,(here T is the nu*er of return o*ser!ations
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Methods of Index Portfolio Investing
9ndex FundsExact replication in ters of securities 1
(ei$hts
o( tradin$ and ana$eent expense ratios
The ad!anta$e - an inexpensi!e (a# forin!estors to ac"uire a di!ersified portfolio
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Methods of Index Portfolio Investing
Exchan$e-Traded Funds ETF,ETFs are depositor# receipts of the securities
that are held in deposit *# a financial institutionthat issued the certificates
Ad!anta$e of ETFs - can *e *ou$ht 1sold; %acked *# a sponsor2 saller fee2 continuous
tradin$ (hen /E is open;exaple of ETFs
G 90909 Prudential 078 344 ETFG /E7/E8 Prudential 90909 Exchan$e Traded Fund
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An Overview of Active Strategies
Hoal > earn I than a passi!e %& portfolio2net of transaction costs2 on a risk-ad'usted *asis;7eed to select an appropriate *enchark
Practical difficulties of acti!e ana$er )ffsettin$ Transactions costs *# superior
perforance
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E"uit# Portfolio 9n!estent Philosophiesand /trate$ies
Passi!e &ana$eent /trate$ies
3; Efficient &arket
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!undamental Strategies
Top-o(n !ersus %otto-Jp ApproachesTop-o(n
%road countr# and asset class allocations
/ector allocation decisions
9ndi!idual securities selection
%otto-Jp /ecurities selection (ithout an# initial arket or
sector anal#sis For a portfolio *# purchasin$ e"uities at a
su*stantial discount to (hat his or her !aluationodel indicates its (orth
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!undamental Strategies
Three Heneric Thees3; Tie the e"uit# arket *# shiftin$ funds into andout of stocks2 *onds2 and T-*ills tactical asset allocation,
5; /hift funds aon$ different e"uit# sectors andindustries or aon$ in!estent st#les;
sector rotation strate$#,
K; o stock pickin$ and look at indi!idual issues inan attept to find under!alued stocks
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!undamental Strategies
The 3K4K4 /trate$#on$ positions up to 3K4O 1 short positions up
to K4O
/hortin$ creates the le!era$e needed2 ↑ *othrisk and expected returns copared to thefunds %&;
Ena*le ana$ers to ake full use of their
fundaental research to *u# the under!alued 1short the o!er!alued
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Technical Strategies 0ontrarian 9n!estent /trate$#
The *elief - *est tie to *u# sell, a stock is (hen the a'orit# ofother in!estors are the ost *earish *ullish, a*out it
The concept of ean re!ertin$;The o!erreaction h#pothesis - e%ondt 1 Thaler,; > in!estors
o!erreact to $ood*ad ne(s; The# contend #ou could see
su*se"uent a*noral returns o!e in the opposite direction; thee!idence stron$er for loser than (inners,;
Price &oentu /trate$#
Focus on the trend of past prices alone and akes purchase andsale decisions accordin$l# Assue that recent trends in past prices (ill continue;0han2 Me$adeesh2 and akonishok 3, found 'ustification of this
strate$#;
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Anomalies and Attri"utes
Earnin$s &oentu /trate$#&oentu is the difference of actual EP/ to the expected EP/Purchase stocks that ha!e acceleratin$ earnin$s and sell or
short sell, stocks (ith disappointin$ earnin$s
0alendar-Related AnoaliesThe Qeekend Effect *u# &onda# sell Frida#,The Manuar# Effect in!est in Manuar#,
Fir-/pecific Attri*utesFir /i@e /all fir produces hi$her risk ad'usted return,PE and P%N ratios firs (ith lo(er PE 1 P%N produce *i$$er
risk ad'usted returns than (ith firs ha!in$ hi$her PE 1 P%N,;
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Tax Efficiency and Active EquityManagement
Acti!e portfolio ana$ers - need toconsider taxes (hen sellin$ or holdin$ astock (hose !alue has increased
9f sold at a profit2 for capital $ains taxes are paid and less is left to rein!est;
The rein!estent securit# needs to ha!e asuperior return to ake up for these taxes;
The si@e of the expected return depends on theexpected holdin$ period 1 the cost includin$ theaount of the capital $ain tax paid;
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Tax Efficiency and Active EquityManagement
&easures of Tax Efficienc#Portfolio Turno!er indirect easure,
total rupee !alue of the securities sold di!ided*# the a!era$e rupee !alue of the assets;
Tax 0ost Ratio O, direct easure, The Forula
Tax Cost #atio $ %& ' (& ) TA#*+(& ) PT#*, -&..
(here PTR = pretax returnTAR = tax-ad'usted return
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Tax Efficiency of Passive & Active
Stock Funds Acti!e fund hi$h
Exp Ratio 1PT);
Acti!e fundoutperfored in3 1 6 #ear onpre Tax return
*ut not so in ATR for 3 #ear;
/anguard0.. Index!und
M!S#esearch!und
&$t App Passi!e Acti!e
Exp Ratio 4;3O 3;4LO
Port T) 35O SKO
6 :r A!e;Pre Tax ret
5;53O K;6O
Tax Ad' ret 3;O 5;34O
Tax 0ost Ra 4;K5O 3;L3O3 :r A!e;PTR
3L;3O 36;LO
Tax Ad' ret 3L;64O ;66O
Tax 0ost Ra 4;KO 6;O
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/alue versus 1rowth
PE = 0urrent price per shareEP/ Hro(th-oriented in!estor (illU
Focus on EP/ and its econoic deterinants
ook for copanies expected to ha!e rapid EP/$ro(th
Assues constant PE ratio
Nalue-oriented in!estor (illUFocus on the price coponent7ot care uch a*out current earnin$s
Assue the PE ratio is *elo( its natural le!el
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Style Analysis
0onstruct a portfolio to capture one or oreof the characteristics of e"uit# securities /all-cap stocks2 lo(-PE stocks2 etcV
Nalue stockso( Price%ook !alue or PriceEarnin$s ratios
Hro(th stocks
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2oes Style Matter3
0hoice to ali$n (ith in!estent st#le toclients;
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Asset Allocation Strategies
9nte$rated asset allocation0apital arket conditions9n!estors o*'ecti!es and constraints
/trate$ic asset allocation0onstant-ix
Tactical asset allocation&ean re!ersion
9nherentl# contrarian 9nsured asset allocation
0onstant proportion
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9nte$rated asset allocation
Three step process3; 0apital arket conditions and in!estor -
specific o*'ecti!es 1 constraints e;$;2 risktolerance2 in!estent hori@on2 tax status,;
5; 0o*inin$ the a*o!e inforation2 select the*est portfolio;
K; 0opare the actual perforance (ith the
ana$ers ori$inal expectations;Follo(in$ this coparison ake ad'ustents to theportfolio *# includin$ ne( inforation into theoptii@ation process;
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/trate$ic asset allocation
9s used to deterine the T polic# asset(ei$hts in a portfolio *# considerin$ the Ta!era$e asset returns2 risk2 and
co!ariances; Efficient frontiers are $enerated usin$ the
a*o!e entioned historical inforation andthe in!estor decided (hich asset ix is
appropriate for hisher plannin$ hori@on; This results in a constant-ix asset
allocation (ith periodic re*alancin$;
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Tactical asset allocation Ad'ust the asset class ix to chan$in$ arket conditions;
These ad'ustents are solel# *# percei!ed chan$es in the relati!e!alues of the !arious asset classesW
The in!estors risk tolerance 1 in!estent constraints are assued to*e constant o!er tie;
9t is *ased on the preise of ean re!ersionU a securit#s return (ill
e!entuall# re!ert to its T a!era$e ean, !alue;This assessent is done on coparati!e *asis; /uppose the noralstock and *ond return is 3;52 reflectin$ the $reater de$ree of risk ine"uit# and if the stocks return (ere suddenl# dou*led those of *ondreturns; 9t (ill call for o!er(ei$hin$ the *ond coponent in his portfolio;
sa# shiftin$ fro 4-L4 percent initial strate$ic ix to 64-64 percentsplit,; 9t is inherentl# contrarian ethod of in!estin$; The in!estor adoptin$
this approach (ill al(a#s *e *u#in$ the asset class that is currentl# outof fa!our on a relati!e *asis; Ex; A*o!e exaple,
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9nsured asset allocation
Results in continual ad'ustents in the portfolio allocation2assuin$ that the expected arket returns and risks areconstant o!er tie2 (hile the in!estors o*'ecti!es andconstraints chan$e as his or her (ealth position chan$es;
Ex; Portfolio !alue X leads to X (ealth2 eans he can X hisexposure to risk# assets and !ice-!ersa;
)ften 9AA in!ol!es onl# coon stocks 1 T %ills;
As stock price X2 the AA X the stock coponent;
As stock price Y2 the AA Y the stock coponent;
This is called as constant proportion strate$#; opposite totactical asset allocation,;
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/AA constant ix, 1 9AAconstant proportion,
Date Stock BondPortfoliovalue Stock ratio Bond ratio
01-01-15 000 !000 10000 0 !0
"1-0"-15 "00 !0#0 10"#0 0$% "%$"1
SAA # !15 10"#0 0 !0
IAA "00 !0#0 10"#0 0$% "%$"1
"1-0-15 5'00 !10 %#0 5'$#1 !$1%
SAA 5%1 "%!! %#0 0 !0
IAA 5'00 !10 %#0 5'$#1 !$1%
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Asset Allocation Strategies
/electin$ an Acti!e Allocation ðodPerceptions of !aria*ilit# in the clients
o*'ecti!es and constraintsPercei!ed relationship *et(een the past and
future capital arket conditionsThe in!estors needs and capital arket
conditions are can *e considered constantand can *e considered !aria*le