Equity portfolio management strategies

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Equity portfolio management strategies
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Objective
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Outline
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Portfolio management style

• Passive
• Buy and hold strategy, often known as indexing
• Active
• Continuos rebalancing

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Passive management

• Techniques
• Full replication
• Issues Transaction costs
• Sampling
• Issues Tracking error
• Quadratic optimization
• Issues Programming
• Completeness funds
• Issues Special benchmark to complement active
  portfolio management

• Objective
• Match the return of a benchmark
• Approach
• Replicate the benchmark

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Active management

• Objective
• Outperform a passive benchmark portfolio on a
  risk adjusted basis
• Portfolio return gt Benchmark return transaction
  costs
• Issues
• Benchmark
• Measuring returns on a risk adjusted basis

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Themes in active portfolio management

• Sector rotation
• Value vs. growth
• Earnings price momentum
• Factors models
• Identify stocks that are sensitive to
  _________factors
• Long-short approach
• Screen rank buy the top, sell the bottom

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Style analysis

• Compare managers return to that of different
  styles of indices
• Grid style
• Regression analysis

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Style analysis Grid style
SP 5000
Russel 1000
Wilshire 5000
TSE300
Russel midcap
Nasdaq
Russel 2000
Joe B.
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Style 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 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 strategies

• Integrated asset allocation
• Strategic asset allocation
• Tactical asset allocation
• Insured asset allocation

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Integrated asset allocation

• Evaluate and integrate
• Capital market conditions
• Investors objectives constraints

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Integrated asset allocation
Investors assets, liabilities, and net worth
Capital market conditions
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Strategic 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 allocation

• Assumption
• Mean reversion
• Aka. timing the market
• Its a contrarian strategy
• Buy low, sell high

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Insured asset allocation

• Assumption
• Returns risks constant over time, but investors
  change
• Switch between equity cash to accommodate
  investors risk tolerance
• Similar to integrated asset allocation without
  feedback on the capital market side

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Evaluation of portfolio performance

• Requirements of a good portfolio manager
• Derive no less than average returns for a given
  risk-class (timing security selection skills)
• Diversify away all non-systematic risk

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Approaches to measuring performance

• Peer-group comparisons
• Treynors composite measure
• Shapres measure
• Jensens measure
• Famas approach
• Attribution analysis
• Market timing skills measurement

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Peer-group comparisons

• Ranking can be random
• Most data tracks funds, not individual portfolio
  managers
• See also textbook

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Treynors 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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Sharpes 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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Jensens measure

• Measures excess return (above and beyond that
  required by the market)
• (Ri - Rf) a (Rm - Rf)bi e
• If a gt 0
• Portfolio earned more than the required rate
• If a lt 0
• Portfolio earned less than the required rate
• Issues
• Uses realized returns

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Famas approach

• Excess return Portfolio risk Selectivity
• See also textbook

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Attribution 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 Exemplification
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Attribution analysis Exemplification
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Attribution analysis Exemplification
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Attribution analysis Exemplification
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Attribution analysis Exemplification
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Attribution 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

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Attribution analysis Interpretation

• Manager underperformed benchmark by 0.02 due to
  deviations from benchmarks weight
• Manager outperformed the benchmark by 0.54, due
  to its superior selection skills

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Measuring timing skills

• Measure the effectiveness of switching between
  asset classes
• Having perfect timing skills (hindsight 20/20) is
  equivalent to owning a lookback 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 measures

• Knowing what is the true return generating
  process
• All the above measures are based on CAPM
• Finding the real market portfolio
• Changing the proxy for the market portfolio
  completely changes the ranking
• Accounting for managers style

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A question of benchmark

• Portfolio managers have different objectives and
  styles.
• Wee need customized benchmarks.

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The making of a good benchmark

• Unambiguous
• Investable
• Measurable
• Appropriate Consistent with managers style
• Reflective of managers current investment
  opinions
• Specified in advance