0324289030_51928

8/4/2019 0324289030_51928

http://slidepdf.com/reader/full/032428903051928 1/33

Lecture Presentation Software to accompany

Investment Analysis and Portfolio Management

Eighth Edition

by

Frank K. Reilly & Keith C. Brown

Chapter 16

8/4/2019 0324289030_51928


Chapter 16 - Equity PortfolioManagement Strategies

Questions to be answered:

• What are the two generic equity portfolio management

styles?

• What are three techniques for constructing a passive index portfolio?

• How does the goal of a passive equity portfolio manager

differ from the goal of an active manager?• What is a portfolio’s tracking error and how is it useful in

the construction of a passive equity investment?

8/4/2019 0324289030_51928



• What is the difference between an index mutual

fund and an exchange-traded fund?

• What are the three themes that active equity

portfolio managers can use?

• What stock characteristics differentiate value-

oriented and growth-oriented investment styles?

• What is style analysis and what does it indicate

about a manager’s investment performance?

8/4/2019 0324289030_51928



• What techniques are used by active managers in

an attempt to outperform their benchmark?

• What are differences between the integrated,

strategic, tactical, and insured approaches to asset

allocation?

8/4/2019 0324289030_51928


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

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

portfolio on a risk-adjusted basis

8/4/2019 0324289030_51928


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

8/4/2019 0324289030_51928


Index Portfolio Construction

Techniques

• Full replication

• Sampling

• Quadratic optimization or

programming

8/4/2019 0324289030_51928


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

8/4/2019 0324289030_51928


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

8/4/2019 0324289030_51928


Expected Tracking Error Between the S&P 500

Index and Portfolio Comprised of Samples of Less

Than 500 StocksExhibit 16.2

500 400 300 200 100 0

2.0

1.0

3.0

4.0

Expected Tracking

Error (Percent)

Number of Stocks

8/4/2019 0324289030_51928


Quadratic Optimization

(or programming techniques)• Historical information on price changes and

correlations between securities are input

into a computer program that determines thecomposition of a portfolio that will

minimize tracking error with the benchmark

• This relies on historical correlations, whichmay change over time, leading to failure to

track the index

8/4/2019 0324289030_51928


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 bya financial institution that issued the certificates

8/4/2019 0324289030_51928


An Overview of Active Equity

Portfolio Management Strategies• Goal is to earn a portfolio return that

exceeds the return of a passive benchmark

portfolio, net of transaction costs, on a risk-adjusted basis

• Practical difficulties of active manager

– Transactions costs must be offset – Risk can exceed passive benchmark

8/4/2019 0324289030_51928


Fundamental Strategies

• Top-down versus bottom-up approaches

• Asset and sector rotation strategies

8/4/2019 0324289030_51928


Sector Rotation

• Position a portfolio to take advantage of the

market’s next move

• Screening can be based on various stock

characteristics:

– Value

– Growth

– P/E

– Capitalization

– Sensitivity to economic variables

8/4/2019 0324289030_51928


Technical Strategies

• Contrarian investment strategy

• Price momentum strategy

• Earnings momentum strategy

8/4/2019 0324289030_51928


Anomalies and Attributes

• The Weekend Effect

• The January Effect

• Firm Size

• P/E and P/BV ratios

8/4/2019 0324289030_51928


Miscellaneous Issues

• Selection of an appropriate benchmark

• Issues pertaining to the benchmark

• Use of computer screening and other

quantitatively based methods of evaluating

stocks

• Factor models

• The “long-short” approach to investing

8/4/2019 0324289030_51928


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 growthstocks

8/4/2019 0324289030_51928


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

8/4/2019 0324289030_51928


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

8/4/2019 0324289030_51928


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

8/4/2019 0324289030_51928


Does Style Matter?

• Choice to align with investment style

communicates information to clients

• Determining style is useful in measuring

performance relative to a benchmark

• Style identification allows an investor to

diversify by portfolio

• Style investing allows control of the total

portfolio to be shared between the investment

managers and a sponsor

8/4/2019 0324289030_51928


Determining Style

• Style grid:

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

– Relative value (value, blend, growth)characteristics

• Style analysis

– constrained least squares

8/4/2019 0324289030_51928


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

8/4/2019 0324289030_51928



• 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-priceratio, book-to-price ratio, earnings variability,

financial leverage, foreign income, labor

intensity, yield, and low capitalization

8/4/2019 0324289030_51928



• 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

8/4/2019 0324289030_51928


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

8/4/2019 0324289030_51928


Asset Allocation Strategies

• Integrated asset allocation – capital market conditions

– investor’s objectives and constraints

• Strategic asset allocation – constant-mix

• Tactical asset allocation – mean reversion

– inherently contrarian

• Insured asset allocation – constant proportion

8/4/2019 0324289030_51928


Asset Allocation Strategies

• Selecting an allocation method depends on: – Perceptions of variability in the client’s

objectives and constraints

– Perceived relationship between the past andfuture capital market conditions

8/4/2019 0324289030_51928


The Internet

Investments Onlinehttp://www.russell.com

http://www.firstquadrant.comhttp://www.panagora.com

http://www.russell.com/

http://www.firstquadrant.com/

http://www.panagora.com/


http://www.firstquadrant.com/

http://www.russell.com/

8/4/2019 0324289030_51928


End of Chapter 16

– Equity Portfolio ManagementStrategies






8/4/2019 0324289030_51928


Future topics

Chapter 17 • Bond Fundamentals






Documents

0324289030_51928