equity portfolio management strategies reilly and brown

PresentingEquity Portfolio

Management

Strategies

Name ID

Md. Omar Faruq 1484

Md Tariqul Islam 1504

Md enamul hasan. 2315

Anik Banik. 2317

khondakar masun amin sajib 2318

Group “Adroit”

Equity Portfolio Management

Why equities in a portfolio?

• Equities have historically served as a good inflation hedge. When-

Inflation can be priced into the stock.

Inflation can be passed through the consumer.

• Provides a growth dimension to the portfolio.

Passive versus Active Management

• Passive equity portfolio management– Long-term buy-and-hold strategy,

– Usually tracks an index over time,

– Designed to match market performance,

– Manager is judged on how well they track the target index.

Passive versus Active Management

• Active equity portfolio management– Attempts to outperform a passive benchmark

portfolio on a risk-adjusted basis.

Passive equity strategies

An Overview of Passive Equity Portfolio Management Strategies

Replicate the performance of an index.

May slightly underperform the target index due to fees and commissions.

Costs of active management (1 to 2 percent) are hard to overcome in risk-adjusted performance.

Many different market indexes are used for tracking portfolios.

Index Portfolio Construction Techniques

• Full replication.

• Sampling.

• Quadratic optimization or

programming.

Full Replication

• All securities in the index are purchased in proportion to weights in the index.

• This helps ensure close tracking.

• Increases transaction costs, particularly with dividend reinvestment.

Sampling

• Buys a representative sample of stocks in the benchmark index according to their weights in the index.

• Fewer stocks means lower commissions.

• Reinvestment of dividends is less difficult.

• Will not track the index as closely, so there will be some tracking error.

Expected Tracking Error Between the S&P 500 Index and Portfolio Comprised of Samples of Less

Than 500 Stocks

Exhibit 16.2

500 400 300 200 100 0

2.0

1.0

3.0

4.0

Expected Tracking Error (Percent)

Number of Stocks

Quadratic Optimization (or programming techniques)

• Historical information on price changes and correlations between securities are input into a computer program that determines the composition of a portfolio that will minimize tracking error with the benchmark.

• This relies on historical correlations, which may change over time, leading to failure to track the index.

Methods of Index Portfolio Investing

• Index Funds– Attempt to replicate a benchmark index.

• Exchange-Traded Funds– EFTs are depository receipts that give

investors a pro rata claim on the capital gains and cash flows of the securities that are held in deposit by a financial institution that issued the certificates.

“Value”

versus

“Growth”Investing

Value Stock

• Trading at a discount to “Intrinsic Value.”

• Features-

Lower P/E ratio.

Dividends.

Growth Stock

• Potential for future earnings growth.

• Features-

Higher P/E ratio.

No dividends.

“Growth and Value investing are joined at the hip.”

-Warren Buffet.

Value versus Growth

Growth stocks will outperform value stocks for a time and then the opposite occurs.

Over time value stocks have offered somewhat higher returns than growth stocks.

Value versus Growth

• Growth-oriented investor will:

focus on EPS and its economic

determinants.

look for companies expected to have

rapid EPS growth.

assumes constant P/E ratio.

Value versus Growth

• Value-oriented investor will:

–focus on the price component.

–not care much about current earnings.

–assume the P/E ratio is below its

natural level.

Style

Style

• Construct a portfolio to capture one or more of the characteristics of equity securities

• Small-capitalization stocks, low-P/E stocks, etc…

• Value stocks appear to be underpriced– price/book or price/earnings.

• Growth stocks enjoy above-average earnings per share increases.

Determining Style

• Style grid:

– firm size (large cap, mid cap, small cap).

– Relative value (value, blend, growth) characteristics.

• Style analysis

– constrained least squares.

Benchmark Portfolios

• Sharpe– T-bills, – intermediate-term government bonds, – long-term government bonds, – corporate bonds, – mortgage related securities,– large-capitalization value stocks, – large-capitalization growth stocks, medium-capitalization

stocks, – small-capitalization stocks, – non-U.S. bonds, – European stocks,– and Japanese stocks

Benchmark Portfolios

• Sharpe

• BARRA– Uses portfolios formed around 13 different

security characteristics,

– including variability in markets, past firm success, firm size, trading activity, growth orientation, earnings-to-price ratio, book-to-price ratio, earnings variability, financial leverage, foreign income, labor intensity, yield, and low capitalization

Benchmark Portfolios

• Sharpe

• BARRA

• Ibbotson Associates

– simplest style model uses portfolios formed around five different characteristics:

– cash (T-bills), large-capitalization growth, small-capitalization growth, large-capitalization value, and small-capitalization value

Timing Between Styles

• Variations in returns among mutual funds are largely attributable to differences in styles

• Different styles tend to move at different times in the business cycle

Active equity Strategies

An Overview of Active Equity Portfolio Management Strategies

Total actual return= expected return + alpha

Management strategies

Fundamental strategies.

Technical strategies .

Market anomalies and attributes.

Tax efficiency and active equity portfolio .

Fundamental strategies

Active fundamental managers use threegeneric themes.

Asset class rotation strategy Shifting fund in and out of the stock market

depending managers perception how stock isvalue compared to the various asset classalternative.

Sector rotation strategy.

130/30 strategy.

Technical analysis

Contrarian investment strategy.

Base other belief that the best time to a stock is when the majority other investors are the most bearish or bullish.

Price momentum strategy.

Earnings momentum strategy.

Disadvantages: technical analysis

Past price pattern may not be repeated in the future.

The intense competition of those using the trading rules will render the technique useless.

The values that signal action constantly changing.

Anomalies and attributes

• The Weekend Effect.

• The January Effect.

• Firm Size.

Tax efficiency and active equity management

• Passive equity portfolio.

• Active equity portfolio.

• Pension fund and university endowment funds.

• Tax cost ratio.

Asset allocation strategies

Asset Allocation Strategies

1.Integrated asset allocation

2.Strategic asset allocation

3.Tactical asset allocation

4.Insured asset allocation

Integrated Asset Allocation

The integrated asset allocation strategy examines, capital market conditions and investor’s objectives and constraints .These factors are combined to establish the portfolio asset mix .

Strategic Asset Allocation

Strategic asset allocation is a constant mix asset allocation with periodic rebalancing to adjust the

portfolio to the specified asset weights.

Tactical asset allocation

-Mean reversion

-Inherently contrarian

Insured Asset Allocation

Insured asset allocation results in continual adjustment in the portfolio allocation assuming that expected market returns and risk are constant over

time.

Selecting an Active Allocation Method

-Depend on the perceptions of the variability

-Perceived relationship between past and future capital market condition.

Thank you all.