Transcript Equity Portfolio Management

Equity Portfolio
Management
Role of the Equity Portfolio
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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
Equity Investment
passive management
 active management
 semiactive management
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Passive Management
no attempt to reflect investment
expectations through changes in security
holdings
 indexing
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 attempt
to match the performance of some
benchmark
 in US alone, more than $1 trillion in
institutional indexed equities
Active Management
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principle way historically that investors
manage equities
 even
with growth of indexing, still accounts for
overwhelming majority of equity assets
managed
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seek to outperform benchmark
Semiactive Management
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enhanced indexing or risk-controlled active
management
 seek
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
Expected
Active
Return
Tracking
Risk
Information
Ratio
Indexing
Enhanced
Indexing
Active
0%
1% - 2%
2% +
<1%
1% - 2%
4% +
0
0.75
0.50
Passive Equity Investing
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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 broadmarket index fund for retail investors
Indexing
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many studies have found that the average active
institutional portfolio fails to beat the relevant comparison
index after expenses
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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
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portfolio turnover
management fees
high tax efficiency
Equity Indices
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indexes are portfolio management benchmarks
also used
 to
 as
measure return of a market or market segment
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
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characteristics of index
 boundaries
of index’s universe
 criteria for inclusion in the index
 how the stocks are weighted
 how returns are calculated
Index Weighting
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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
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float-weighted index
equal-weighted – each stock is weighted equally
different weighting schemes can lead to different biases
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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
Selection
Stephen 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.
2.
3.
4.
2.
PW index
VW index
Float-weighted index
EW index
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
12/31/2002
Kodak
McDonald's
Intel
Merck
Wal-Mart
Microsoft
Total
35.04
16.08
15.57
53.58
50.51
25.85
Share price
12/31/2003
24.85
24.09
31.36
45.1
53.05
27.37
Price
Change
-29.10%
49.80%
101.40%
-15.80%
5.00%
5.90%
MV Shares MV Shares Free Float
12/31/2002 12/31/2003 Factor
(millions)
(millions)
10,056
7,132
1
20,406
30,570
1
101,703
204,844
1
119,216
100,348
1
221,992
233,154
0.6
277,060
293,352
0.85
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
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Indexed Portfolios
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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
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equity styles – natural grouping of investment
disciplines that has some predictive power in
explaining the future dispersion of returns across
portfolios
– focused on paying a relatively low share price
in relation to earnings or assets per share
 growth – focused on investing in high-earningsgrowth companies
 market-oriented – specified as an intermediate
grouping for investment disciplines that cannot be
clearly categorized as value or growth
 value
Value and Growth Styles
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Value substyles
 low
P/E
 contrarian
 high yield
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Growth substyles
 consistent
growth
 earnings momentum
Equity Styles
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Blend or Core Investor
 market-oriented
 market-oriented
with a value (growth) bias
 growth-at-a-reasonable-price
 style rotators
Active Investing
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Socially Responsible Investing
 integrates
ethical values and societal
concerns with investment decisions
 negative screens
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Long-Short Investing
 value
added is alpha
 market neutral strategy
 pairs trade/pairs arbitrage
Long-Short Investing
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price inefficiency on the short side
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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, windowdressing, 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
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long-short strategies can make better use of a portfolio manager’s
information because both rising and falling stocks offer profit
potential
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rather than simply avoiding a stock with a bad outlook, a long-short
manager can short it thereby earning the full performance spread
Semiactive Equity Investing
enhanced index or risk-controlled active
strategies
 basic forms
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 derivatives-based
strategies
 stock-based strategies