Equity Portfolio Management. Role of the Equity Portfolio significant source of wealth today...
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Transcript of Equity Portfolio Management. Role of the Equity Portfolio significant source of wealth today...
Role of the Equity Portfolio
significant source of wealth today equities constitute differing proportions of
average portfolio weights in different countries one characteristic important to investors across
markets is ability to be an inflation hedge equities have comparatively high historical long-term
rates of return in study of 17 countries the long term real rates of
return to equities exceeded that of bonds in all countries
Passive Management
no attempt to reflect investment expectations through changes in security holdings
indexingattempt to match the performance of some
benchmark in US alone, more than $1 trillion in
institutional indexed equities
Active Management
principle way historically that investors manage equitieseven with growth of indexing, still accounts for
overwhelming majority of equity assets managed
seek to outperform benchmark
Semiactive Management
enhanced indexing or risk-controlled active managementseek to outperform benchmark but manager
worries more about tracking risk than active manager and builds portfolio that will have limited volatility around benchmark’s return
Indexing, Enhanced Indexing, and Active Approaches: A Comparison
Indexing Enhanced Indexing
Active
Expected Active Return
0% 1% - 2% 2% +
Tracking Risk
<1% 1% - 2% 4% +
Information Ratio
0 0.75 0.50
Passive Equity Investing
1971 - Wells Fargo 1st indexed portfolio 1973 – Wells Fargo has commingled index fund
for trust accounts 1976 – Wells Fargo combines funds and uses
S&P 500 as template for combined portfolio 1981 – Wells Fargo has fund to track market
outside of S&P 500 1975 – Bogle at Vanguard launches 1st broad-
market index fund for retail investors
Indexing
many studies have found that the average active institutional portfolio fails to beat the relevant comparison index after expenses often difference in performance is found to be close to average
expense disadvantage of active management compared with the average actively managed fund that has
similar objectives, a well-run indexed fund’s major advantage is expected superior long-term net-of-expenses performance because of relatively low
portfolio turnover management fees high tax efficiency
Equity Indices
indexes are portfolio management benchmarks also used
to measure return of a market or market segment
as basis for creating an index fund to study factors that influence share price movements to perform technical analysis to calculate a stock’s systematic risk
Equity Indices
characteristics of indexboundaries of index’s universecriteria for inclusion in the indexhow the stocks are weightedhow returns are calculated
Index Weighting
one of greatest differences among indexes due to how components are weighted price-weighted – each stock is weighted according to its absolute share
price value-weighted – each stock is weighted according to its market cap
float-weighted index equal-weighted – each stock is weighted equally
different weighting schemes can lead to different biases PW biased towards highest price stock VW biased towards the shares of firms with the largest market caps
(likely large and mostly mature firms and possibly overvalued firms) EW biased towards small firms because these indexes have many more
small firms than large firms and it must be rebalanced periodically
Problem of Benchmark Index SelectionStephen Alcorn is a portfolio manager at Amanda Asset Management (AAM). At the end
of 2002, a wealthy client engaged Alcorn to manage $10,000,000 for one year in an active focused equity style. the investment management contract specificed a symmetric incentive fee of $10,000 per 100 bps of capital appreciation relative to that of an index of the stocks slected for investment. (Symmetric means that the incentive fee will reduce the investment management fee if benchmark-relative performance is negative.) In an oversight, the contract leaves open the method by which the benchmark index will be calculated. Alcorn invests in shares of Eastman Kodak, McDonald’s, Intel, Merck, Wal-Mart, and Microsoft achieving a 15.9% price return for the year. The table gives information on the 6 stocks. Using only the information given, address the following:
1. For each of the 6 shares, explain the price-only return calculation on the following indices for the period 12/31/2002 to 12/31/2003:1. PW index2. VW index3. Float-weighted index4. EW index
2. Recommend the appropriate benchmark index for calculating the performance incentive fee on the account and determine the amount of that fee.
Equity Market Data for the Shares of Six Companies
Share price Share price Price MV Shares MV Shares Free Float12/31/2002 12/31/2003 Change 12/31/2002 12/31/2003 Factor
(millions) (millions)Kodak 35.04 24.85 -29.10% 10,056 7,132 1McDonald's 16.08 24.09 49.80% 20,406 30,570 1Intel 15.57 31.36 101.40% 101,703 204,844 1Merck 53.58 45.1 -15.80% 119,216 100,348 1Wal-Mart 50.51 53.05 5.00% 221,992 233,154 0.6Microsoft 25.85 27.37 5.90% 277,060 293,352 0.85Total 750,433 869,400
Passive Investment Vehicles
investment in an indexed portfolio a long position in cash plus a long position
in futures contracts on the underlying index
a long position in cash plus a long position in a swap on the index
Indexed Portfolios
conventional index mutual funds exchange-traded funds separate accounts or pooled accounts (mostly
for institutional investors designed to track a benchmark index)
indexing can be done by full replication stratified sampling optimization
Active Equity Investing
equity styles – natural grouping of investment disciplines that has some predictive power in explaining the future dispersion of returns across portfolios value – focused on paying a relatively low share price
in relation to earnings or assets per share growth – focused on investing in high-earnings-growth
companies market-oriented – specified as an intermediate
grouping for investment disciplines that cannot be clearly categorized as value or growth
Value and Growth Styles
Value substyles low P/Econtrarianhigh yield
Growth substylesconsistent growthearnings momentum
Equity Styles
Blend or Core Investormarket-orientedmarket-oriented with a value (growth) biasgrowth-at-a-reasonable-pricestyle rotators
Active Investing
Socially Responsible Investing integrates ethical values and societal
concerns with investment decisionsnegative screens
Long-Short Investingvalue added is alphamarket neutral strategypairs trade/pairs arbitrage
Long-Short Investing
price inefficiency on the short side many investors look for undervalued stocks but because of the
constraints many have on shorting, fewer search for overvalued stocks opportunities to short may arise due to management fraud, window-
dressing, or negligence sell-side analysts issue many more reports with buy recommendations
than with sell recommendations sell-side analysts may be reluctant to issue negative opinions on
companies’ stocks for reasons other than generic ones such as that a stock has become relatively expensive
long-short strategies can make better use of a portfolio manager’s information because both rising and falling stocks offer profit potential rather than simply avoiding a stock with a bad outlook, a long-short
manager can short it thereby earning the full performance spread