Managing Equity Portfolios Flashcards
(34 cards)
What is Fundamental indexing
each stock’s index weighting is determined by four fundamental measures — not by its expected future size, as reflected in market capitalization
four fundamental measures of Fundamental Indexing
- Trailing five-year cash flow (cash flow)
- Trailing five-year sales (sales)
- Trailing five-year gross dividends (dividends)
- Book value (book)
drawback of cash flow metric
leads to over- or underexposure to highly cyclical companies.
Book Value Metric - drawback
over or underexposure to companies with aggressive or conservative accounting practices.
What is Risk Budgeting?
a process that limits the deviations of a portfolio’s return from a benchmark - used to create enhanced index portfolio.
What is Enhanced indexing?
Index-like performance with some excess return net of costs
4 steps of risk budgeting process
- Determine benchmark.
- Determine maximum acceptable tracking error.
- Identify tactical asset allocation or specific return opportunities
- Build a portfolio that deviates from the benchmark using the return opportunities identified in step three
Purpose of step 2 in risk budgeting process (determine maximum acceptable tracking error)
sets a maximum for how large of an unexpected return “surprise” the portfolio could experience.
Final purpose of risk budgeting
Maximize Portfolio’s expected excess returns without exceeding the tracking error limit determined in step two
What is the selection dimension? (Active Manager)
identify underpriced securities
What is the timing dimension (Active Manager)
anticipate general market movements
sustainable growth rate equals…
Return on equity multiplied by the retention rate.
How are enhanced active equity portfolios constructed?
by selling short undesirable smaller stocks and reinvesting the short sale proceeds into desirable long positions.
two strategies to use in market-neutral investing:
absolute return and alpha portability
what kind of strategy is long-short?
Absolute
long-short equity strategy, there are two primary sources of return.
- Return from the long position greater than short position
* T-Bill Component
long-only active investment managers try to build returns from two sources:
- exposure to systematic/market risk (beta)
* exposure to unsystematic / active risk (alpha).
A portable alpha strategy consists of three components
The beta portfolio
The alpha portfolio
The cash portfolio
three approaches to constructing an index fund
- replicating an index
- tracking an index
- fundamental indexing
With this approach, a portfolio manager constructs a subset of the benchmark that faithfully mimics an index
Index tracking
portfolio management styles fall into two categories
Active and Passsive
How does replicating an index work?
manager holds each stock in the fund’s portfolio in exact proportion to its weighting within the index.
Preferred methodology of constructing an index?
Index tracking
value fund’s objectives are (2)
income and capital preservation