16042016 equity portfolio management strategies

8/17/2019 16042016 Equity Portfolio Management Strategies

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Equity Portfolio Management Strategies

Passive versus Active Management

Total Portfolio Return=[Expected Return] + [“Alpha”]

=[Risk-Free Rate + Risk Preiu] + [“Alpha”]


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Passive versus Active Management

Passi!e e"uit# portfolio ana$eent%u#-and-holdtrackin$ an indexatchin$ arket perforance&ana$er 'ud$ed - ho( (ell the# track the tar$et

index Acti!e e"uit# portfolio ana$eent

)utperfor a passi!e %& portfolio on a risk-

ad'usted *asis $eneratin$ “alpha”, throu$h tactical ad'ustents or securit#selection,


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An Overview of Passive Strategies

To replicate the perforance of an indexunderperfor o!erperfor the tar$et.

/tron$ rationale for this approach0osts of acti!e ana$eent

&an# arket indexes are used for trackin$ portfolios /1P %/E /ensex2 3442 5442 644 078 79FT: 9ndex2 6442 &idcap


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Index Portfolio ConstructionTechniques

Full Replication/ecurities in proportion

ensures close trackin$

↑ transaction costs di!idend rein!estent,;

Ex;


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/aplin$ A representati!e saple of stocks

Fe(er stocks - lo(er coissions

i!idend Rein!estent less difficult7o close trackin$ > so soe trackin$ error;

Ex;


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?uadratic )ptii@ation or pro$rain$techni"ues,


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Tracing Error and Index Portfolio Construction

Passi!e ana$er $oal

inii@e the portfolios return !olatilit#2i;e;2 to inii@e trackin$ error TE,

Trackin$ Error &easureReturn differential in tie period t

Bt =Rpt > R*t

(here Rpt= return to the ana$ed portfolio in Period t

R*t= return to the *enchark portfolio in Period t.

TE is easured as σ of Bt 2 norall# annuali@ed;

TE = CB DP P is the nu*er of return periods in a #ear2

P = 35 for onthl# return,; (here CB5=Bt > ean B,5 T-3,(here T is the nu*er of return o*ser!ations


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Methods of Index Portfolio Investing

9ndex FundsExact replication in ters of securities 1

(ei$hts

o( tradin$ and ana$eent expense ratios

The ad!anta$e - an inexpensi!e (a# forin!estors to ac"uire a di!ersified portfolio


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Methods of Index Portfolio Investing

Exchan$e-Traded Funds ETF,ETFs are depositor# receipts of the securities

that are held in deposit *# a financial institutionthat issued the certificates

Ad!anta$e of ETFs - can *e *ou$ht 1sold; %acked *# a sponsor2 saller fee2 continuous

tradin$ (hen /E is open;exaple of ETFs

G 90909 Prudential 078 344 ETFG /E7/E8 Prudential 90909 Exchan$e Traded Fund


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An Overview of Active Strategies

Hoal > earn I than a passi!e %& portfolio2net of transaction costs2 on a risk-ad'usted *asis;7eed to select an appropriate *enchark

Practical difficulties of acti!e ana$er )ffsettin$ Transactions costs *# superior

perforance


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E"uit# Portfolio 9n!estent Philosophiesand /trate$ies

Passi!e &ana$eent /trate$ies

3; Efficient &arket


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!undamental Strategies

Top-o(n !ersus %otto-Jp ApproachesTop-o(n

%road countr# and asset class allocations

/ector allocation decisions

9ndi!idual securities selection

%otto-Jp /ecurities selection (ithout an# initial arket or

sector anal#sis For a portfolio *# purchasin$ e"uities at a

su*stantial discount to (hat his or her !aluationodel indicates its (orth


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Three Heneric Thees3; Tie the e"uit# arket *# shiftin$ funds into andout of stocks2 *onds2 and T-*ills tactical asset allocation,

5; /hift funds aon$ different e"uit# sectors andindustries or aon$ in!estent st#les;

sector rotation strate$#,

K; o stock pickin$ and look at indi!idual issues inan attept to find under!alued stocks


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The 3K4K4 /trate$#on$ positions up to 3K4O 1 short positions up

to K4O

/hortin$ creates the le!era$e needed2 ↑ *othrisk and expected returns copared to thefunds %&;

Ena*le ana$ers to ake full use of their

fundaental research to *u# the under!alued 1short the o!er!alued


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Technical Strategies 0ontrarian 9n!estent /trate$#

The *elief - *est tie to *u# sell, a stock is (hen the a'orit# ofother in!estors are the ost *earish *ullish, a*out it

The concept of ean re!ertin$;The o!erreaction h#pothesis - e%ondt 1 Thaler,; > in!estors

o!erreact to $ood*ad ne(s; The# contend #ou could see

su*se"uent a*noral returns o!e in the opposite direction; thee!idence stron$er for loser than (inners,;

Price &oentu /trate$#

Focus on the trend of past prices alone and akes purchase andsale decisions accordin$l# Assue that recent trends in past prices (ill continue;0han2 Me$adeesh2 and akonishok 3, found 'ustification of this

strate$#;


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Anomalies and Attri"utes

Earnin$s &oentu /trate$#&oentu is the difference of actual EP/ to the expected EP/Purchase stocks that ha!e acceleratin$ earnin$s and sell or

short sell, stocks (ith disappointin$ earnin$s

0alendar-Related AnoaliesThe Qeekend Effect *u# &onda# sell Frida#,The Manuar# Effect in!est in Manuar#,

Fir-/pecific Attri*utesFir /i@e /all fir produces hi$her risk ad'usted return,PE and P%N ratios firs (ith lo(er PE 1 P%N produce *i$$er

risk ad'usted returns than (ith firs ha!in$ hi$her PE 1 P%N,;


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Tax Efficiency and Active EquityManagement

Acti!e portfolio ana$ers - need toconsider taxes (hen sellin$ or holdin$ astock (hose !alue has increased

9f sold at a profit2 for capital $ains taxes are paid and less is left to rein!est;

The rein!estent securit# needs to ha!e asuperior return to ake up for these taxes;

The si@e of the expected return depends on theexpected holdin$ period 1 the cost includin$ theaount of the capital $ain tax paid;


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Tax Efficiency and Active EquityManagement

&easures of Tax Efficienc#Portfolio Turno!er indirect easure,

total rupee !alue of the securities sold di!ided*# the a!era$e rupee !alue of the assets;

Tax 0ost Ratio O, direct easure, The Forula

Tax Cost #atio $ %& ' (& ) TA#*+(& ) PT#*, -&..

(here PTR = pretax returnTAR = tax-ad'usted return


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Tax Efficiency of Passive & Active

Stock Funds Acti!e fund hi$h

Exp Ratio 1PT);

Acti!e fundoutperfored in3 1 6 #ear onpre Tax return

*ut not so in ATR for 3 #ear;

/anguard0.. Index!und

M!S#esearch!und

&$t App Passi!e Acti!e

Exp Ratio 4;3O 3;4LO

Port T) 35O SKO

6 :r A!e;Pre Tax ret

5;53O K;6O

Tax Ad' ret 3;O 5;34O

Tax 0ost Ra 4;K5O 3;L3O3 :r A!e;PTR

3L;3O 36;LO

Tax Ad' ret 3L;64O ;66O

Tax 0ost Ra 4;KO 6;O


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/alue versus 1rowth

PE = 0urrent price per shareEP/ Hro(th-oriented in!estor (illU

Focus on EP/ and its econoic deterinants

ook for copanies expected to ha!e rapid EP/$ro(th

Assues constant PE ratio

Nalue-oriented in!estor (illUFocus on the price coponent7ot care uch a*out current earnin$s

Assue the PE ratio is *elo( its natural le!el


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Style Analysis

0onstruct a portfolio to capture one or oreof the characteristics of e"uit# securities /all-cap stocks2 lo(-PE stocks2 etcV

Nalue stockso( Price%ook !alue or PriceEarnin$s ratios

Hro(th stocks


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2oes Style Matter3

0hoice to ali$n (ith in!estent st#le toclients;


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Asset Allocation Strategies

9nte$rated asset allocation0apital arket conditions9n!estors o*'ecti!es and constraints

/trate$ic asset allocation0onstant-ix

Tactical asset allocation&ean re!ersion

9nherentl# contrarian 9nsured asset allocation

0onstant proportion


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9nte$rated asset allocation

Three step process3; 0apital arket conditions and in!estor -

specific o*'ecti!es 1 constraints e;$;2 risktolerance2 in!estent hori@on2 tax status,;

5; 0o*inin$ the a*o!e inforation2 select the*est portfolio;

K; 0opare the actual perforance (ith the

ana$ers ori$inal expectations;Follo(in$ this coparison ake ad'ustents to theportfolio *# includin$ ne( inforation into theoptii@ation process;


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/trate$ic asset allocation

9s used to deterine the T polic# asset(ei$hts in a portfolio *# considerin$ the Ta!era$e asset returns2 risk2 and

co!ariances; Efficient frontiers are $enerated usin$ the

a*o!e entioned historical inforation andthe in!estor decided (hich asset ix is

appropriate for hisher plannin$ hori@on; This results in a constant-ix asset

allocation (ith periodic re*alancin$;


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Tactical asset allocation Ad'ust the asset class ix to chan$in$ arket conditions;

These ad'ustents are solel# *# percei!ed chan$es in the relati!e!alues of the !arious asset classesW

The in!estors risk tolerance 1 in!estent constraints are assued to*e constant o!er tie;

9t is *ased on the preise of ean re!ersionU a securit#s return (ill

e!entuall# re!ert to its T a!era$e ean, !alue;This assessent is done on coparati!e *asis; /uppose the noralstock and *ond return is 3;52 reflectin$ the $reater de$ree of risk ine"uit# and if the stocks return (ere suddenl# dou*led those of *ondreturns; 9t (ill call for o!er(ei$hin$ the *ond coponent in his portfolio;

sa# shiftin$ fro 4-L4 percent initial strate$ic ix to 64-64 percentsplit,; 9t is inherentl# contrarian ethod of in!estin$; The in!estor adoptin$

this approach (ill al(a#s *e *u#in$ the asset class that is currentl# outof fa!our on a relati!e *asis; Ex; A*o!e exaple,


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9nsured asset allocation

Results in continual ad'ustents in the portfolio allocation2assuin$ that the expected arket returns and risks areconstant o!er tie2 (hile the in!estors o*'ecti!es andconstraints chan$e as his or her (ealth position chan$es;

Ex; Portfolio !alue X leads to X (ealth2 eans he can X hisexposure to risk# assets and !ice-!ersa;

)ften 9AA in!ol!es onl# coon stocks 1 T %ills;

As stock price X2 the AA X the stock coponent;

As stock price Y2 the AA Y the stock coponent;

This is called as constant proportion strate$#; opposite totactical asset allocation,;


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/AA constant ix, 1 9AAconstant proportion,

Date Stock BondPortfoliovalue Stock ratio Bond ratio

01-01-15 000 !000 10000 0 !0

"1-0"-15 "00 !0#0 10"#0 0$% "%$"1

SAA # !15 10"#0 0 !0

IAA "00 !0#0 10"#0 0$% "%$"1

"1-0-15 5'00 !10 %#0 5'$#1 !$1%

SAA 5%1 "%!! %#0 0 !0

IAA 5'00 !10 %#0 5'$#1 !$1%


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Asset Allocation Strategies

/electin$ an Acti!e Allocation &ethodPerceptions of !aria*ilit# in the clients

o*'ecti!es and constraintsPercei!ed relationship *et(een the past and

future capital arket conditionsThe in!estors needs and capital arket

conditions are can *e considered constantand can *e considered !aria*le

16042016 equity portfolio management strategies

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