Equity Portfolio Management MIP, Chapter 7

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Equity Portfolio ManagementMIP, Chapter 7

• Kevin C.H. Chiang

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Approached to equity investment

• Passive management
• The dominant approach is indexing
• Active management
• Seeks to outperform a given benchmark
• By overweighting those stocks that deem promising
  and underweighting those stocks that deem less
  promising

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Active return

• Active return the differences between fund
  returns and benchmark returns.
• The goal of active management is try to generate
  consistent positive active returns (holding other
  factors constant, higher the better).

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Tracking ratio and information ratio

• Tracking risk the standard deviation of active
  returns (the lower the better).
• Information ratio the ratio of mean active
  return to tracking risk (the higher the better).
• Some sponsors impose expectations on managers
  tracking risk and information ratio.

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Popular equity indices

• Exhibit 7-10, pp. 420-421.

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Investment style

• Investment style a natural grouping of
  investment disciplines that has some predictive
  power in explaining the future dispersion of
  portfolio/fund returns across portfolios/funds.
• Why one particular style? (1) Drives fund risk
  and fund return, (2) allows research to be more
  focused, (3) aligns with research strengths and
  philosophy, (4) fund/plan sponsors often requires
  style specialization.

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Value style vs. growth style

• Value style investing in high value/price (low
  price/value) stocks e.g., high B/M stocks, low
  P/E stocks.
• A stylized value premium.
• At least 3 sub-styles low P/E, contrarian, and
  high yield.
• Growth style investing in low value/price (high
  value/price) stocks.
• The most popular style among mutual funds.
• At least 2 sub-styles consistent growth (a
  long-history of sales growth, superior earnings),
  and earnings momentum.

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Big-cap style vs. small-cap style

• Used to have a small-cap premium.
• Small-cap style can impose liquidity/depth risk
  on large funds.

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Techniques for identifying styles

• 1st category return-based methods, such as
  regressions or Sharpes style analysis (a special
  form of regression).
• An example of rolling style chart, Exhibit 7-13,
  p. 439)
• 2nd category holdings-based analysis.
• Look into actual stock holdings.
• Morningstar uses this method to construct its 33
  style box for funds (Exhibit 7-18, p.448).

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Style drift

• Drift inconsistency in investment style over
  time.
• An obstacle to investment planning and risk
  management from fund/plan sponsors perspectives.
• Fund/plan sponsors usually monitor for signs of
  style drift managers may need to explain for it.

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SRI

• Socially responsible investing one can consider
  this to be a special style.
• Some fund/plan sponsors today have an SRI
  mandate.
• Some fund/plan sponsors worry that an SRI mandate
  will reduce diversification benefits.

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Screening

• Screening based on some criteria reflecting
  investing style and philosophy, e.g., P/E,
  earnings momentum, etc., is often used by
  research units so that there is focus and
  efficiency in research.

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Structuring research

• Top-down focus research on macroeconomic/industri
  al factors or investment themes.
• The stock holdings in top-down investors
  portfolios reflect their macro insights.
• Bottom-up have little interest in the state of
  the economy or other macro factors, but rather
  try to put together the best portfolio of stocks
  based on company-specific information.

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Sell-side vs. buy-side research

• Sell-side research is generally organized by
  sector/industry with a regional delineation
  e.g., a U.S. banking analyst.
• Buy-side research mainly concerned with
  assembling a portfolio, so decisions on buy-side
  research are usually made through a committee
  structure.
• These research reports/essays are not available
  to outsiders.