manag strateg
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Equity portfolio management strategiesEquity portfolio management strategies
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ObjectiveObjective
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OutlineOutline
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Portfolio management stylePortfolio management style
PassivePassive
Buy and hold strategy, often known as indexing
ActiveActive
Continuos rebalancing
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Passive managementPassive management
ObjectiveObjectiveMatch the return of a benchmark
ApproachApproachReplicate the benchmark
TechniquesTechniques
Full replicationIssues: Transaction costs
SamplingIssues: Tracking error
Quadratic optimizationIssues: Programming
Completeness fundsIssues: Special benchmark to complement active portfolio management
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Active managementActive management
ObjectiveObjectiveOutperform a passive benchmark portfolio on a risk adjusted basison a risk adjusted basis
Portfolio return > Benchmark return + transaction costs
IssuesIssuesBenchmark
Measuring returns on a risk adjusted basis
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Themes in active portfolio managementThemes in active portfolio management
Sector rotation
Value vs. growth
Earnings & price momentum
Factors modelsIdentify stocks that are sensitive to _________factors
Long-short approachScreen & rank; buy the top, sell the bottom
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Style analysisStyle analysis
Compare manager’s return to that of different styles of indices
• Grid style• Regression analysis
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Style analysis: Grid styleStyle analysis: Grid style
ValueValue GrowthGrowth
Small Small capcap
Large Large capcap
Wilshire 5000Wilshire 5000
S&P 5000S&P 5000
Russel midcapRussel midcap
NasdaqNasdaq
Russel 2000Russel 2000
Russel 1000Russel 1000
Joe B.Joe B.
TSE300TSE300
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Style analysis: Regression analysisStyle analysis: Regression analysis
R = b1F1 + b2F2 + ….+ bjFj + …. + e
Where:
R = return on the portfolio under analysis
bj = sensitivity of portfolio to style factor j
Fj = return on a factor j style portfolio
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Style analysis: Regression interpretationStyle analysis: Regression interpretation
Look for (bj)s that are large and significant
They reveal which factor style portfolios are similar to the portfolio under analysis
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Asset allocation strategiesAsset allocation strategies
Integrated asset allocation
Strategic asset allocation
Tactical asset allocation
Insured asset allocation
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Integrated asset allocationIntegrated asset allocation
Evaluate and integrate:
• Capital market conditions• Investor’s objectives & constraints
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Integrated asset allocationIntegrated asset allocation
Capital market conditionsCapital market conditions
Investor’s assets, liabilities, and net worth
Investor’s assets, liabilities, and net worth
PredictionsPredictionsPredictionsPredictions
Expected returns, risk, Expected returns, risk, correlationscorrelations
Expected returns, risk, Expected returns, risk, correlationscorrelations
Investor’s risk tolerance Investor’s risk tolerance functionfunction
Investor’s risk tolerance Investor’s risk tolerance functionfunction
Return evaluation & feedbackReturn evaluation & feedbackReturn evaluation & feedbackReturn evaluation & feedback
FeedbackFeedbackFeedbackFeedback
Investor’s objectivesInvestor’s objectivesInvestor’s objectivesInvestor’s objectives
Optimized portfolio: asset allocation & security selectionOptimized portfolio: asset allocation & security selectionOptimized portfolio: asset allocation & security selectionOptimized portfolio: asset allocation & security selection
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Strategic asset allocationStrategic asset allocation
Classical optimization: It results in a constant asset allocation mix
Similar to integrated asset allocation, without a feedback loop
Exemplification: • Pension plans
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Tactical asset allocationTactical asset allocation
AssumptionAssumption
Mean reversion
Aka. timing the market
It’s a contrarian strategy:
“Buy low, sell high”
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Insured asset allocationInsured asset allocation
AssumptionAssumption
Returns & risks constant over time, but investors change
• Switch between equity & cash to accommodate investor’s risk tolerance
• Similar to integrated asset allocation without feedback on the capital market side
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Evaluation of portfolio performanceEvaluation of portfolio performance
Requirements of a good portfolio manager:
• Derive no less than averageno less than average returns for a given risk-class (timing & security selection skills)
• Diversify away all non-systematic riskall non-systematic risk
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Approaches to measuring performanceApproaches to measuring performance
• Peer-group comparisons• Treynor’s composite measure• Shapre’s measure• Jensen’s measure• Fama’s approach• Attribution analysis• Market timing skills measurement
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Peer-group comparisonsPeer-group comparisons
Ranking can be random
Most data tracks funds, not individual portfolio managers
See also textbook
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Treynor’s composite measureTreynor’s composite measure
Comparison of risk premium per unit of relative risk
Measure
Ti = (Ri - Rf)/bi
Benchmark
Tm = (Rm - Rf)bm
Issues
• Looks at performance only
• Uses realized returns
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Sharpe’s measureSharpe’s measure
Comparison of risk premium per unit of absolute risk
Measure
Si = (Ri - Rf)/si
Benchmark
Sm = (Rm - Rf)sm
Issues
• Looks at performance and diversification
• Uses realized returns
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Jensen’s measureJensen’s measure
Measures excess return (above and beyond that required by the market)
(Ri - Rf) = a + (Rm - Rf)bi + e
If a > 0
Portfolio earned more than the required rate
If a < 0
Portfolio earned less than the required rate
Issues
• Uses realized returns
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Fama’s approachFama’s approach
Excess return = Portfolio risk + Selectivity
See also textbook
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Attribution analysisAttribution analysis
Attribute performance to:
• Selection
• Tactical asset allocation (market timing)
Allocation effect:
[(wp - wb)stocks(Rbstocks - Rb)] + [(wp - wb) bonds(Rbbonds - Rb)] + …
Selection effect:
[wp(Rp - Rb)]stocks + [wp(Rp - Rb)]bonds + …
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Attribution analysis: ExemplificationAttribution analysis: Exemplification
Asset class Portfolio weights Benchmark weights DifferenceStock 0.5 0.6 -0.1Bonds 0.38 0.3 0.08Cash 0.12 0.1 0.02
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Attribution analysis: ExemplificationAttribution analysis: Exemplification
Asset class Portfolio weights Benchmark weights DifferenceStock 0.5 0.6 -0.1Bonds 0.38 0.3 0.08Cash 0.12 0.1 0.02
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Attribution analysis: ExemplificationAttribution analysis: Exemplification
Asset class Portfolio weights Benchmark weights DifferenceStock 0.5 0.6 -0.1Bonds 0.38 0.3 0.08Cash 0.12 0.1 0.02
Asset class Portfolio return Benchmark return DifferenceStock 9.7% 8.6% 1.1%Bonds 9.1% 9.2% -0.1%Cash 5.6% 5.4% 0.2%
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Attribution analysis: ExemplificationAttribution analysis: Exemplification
Asset class Portfolio weights Benchmark weights DifferenceStock 0.5 0.6 -0.1Bonds 0.38 0.3 0.08Cash 0.12 0.1 0.02
Asset class Portfolio return Benchmark return DifferenceStock 9.7% 8.6% 1.1%Bonds 9.1% 9.2% -0.1%Cash 5.6% 5.4% 0.2%
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Attribution analysis: ExemplificationAttribution analysis: Exemplification
Asset class Portfolio weights Benchmark weights DifferenceStock 0.5 0.6 -0.1Bonds 0.38 0.3 0.08Cash 0.12 0.1 0.02
Asset class Portfolio return Benchmark return DifferenceStock 9.7% 8.6% 1.1%Bonds 9.1% 9.2% -0.1%Cash 5.6% 5.4% 0.2%
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Attribution analysis: ExemplificationAttribution analysis: Exemplification
Portfolio return = (0.5)(9.7%) + (0.38)(9.1%) + (0.12)(5.65) = 8.98%
Benchmark return = (0.6)(8.6%) + (0.3)(9.2%) + (0.1)(5.4) = 8.46%
Allocation effect
(-0.1)(8.6% -8.46%) + (0.08)(9.2%-8.46%) + (0.2)(5.4% - 8.465) = -0.02%
Selection effect
(0.5)(9.7% - 8.6%) + (0.38)(9.1% - 9.2%) + (0.12)(5.6% - 5.4%) = 0.54%
Allocation effect + Selection effect = -0.02% + 0.54% = 8.98% - 8.46%Allocation effect + Selection effect = -0.02% + 0.54% = 8.98% - 8.46%
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Attribution analysis: InterpretationAttribution analysis: Interpretation
Manager underperformed benchmark by 0.02% due to deviations from benchmark’s weight
Manager outperformed the benchmark by 0.54%, due to its superior selection skills
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Measuring timing skillsMeasuring timing skills
Measure the effectiveness of switching between asset classesHaving perfect timing skills (hindsight 20/20) is equivalent to owning a lookback optionlookback option:
At expiration, it pays the return of the best-performing asset class.
Ri = Rf + max[(Rb- Rf), (Rst- Rf)]
Regression measure:
(Ri - Rf) = a + (Rb- Rf)bib + (Rst - Rf)bist + y max[(Rb- Rf), (Rst- Rf)] + e
a = excess return
y = proportion of the lookback option captured by manager
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Factors that affect performance measuresFactors that affect performance measures
Knowing what is the true return generating processAll the above measures are based on CAPM
Finding the real market portfolioChanging the proxy for the market portfolio completely changes the ranking
Accounting for manager’s style
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A question of benchmarkA question of benchmark
Portfolio managers have different objectives and styles.
Wee need customized benchmarks.
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The making of a good benchmarkThe making of a good benchmark
• Unambiguous• Investable• Measurable• Appropriate: Consistent with manager’s style• Reflective of manager’s current investment opinions• Specified in advance