CFA 2018 r25 equity portfolio management

Level III Equity Portfolio Management www.ift.world Graphs, charts, tables, examples, and figures are copyright 2014, CFA Institute Reproduced and republished with permission from CFA Institute All rights reserved Contents – Equity Portfolio Management Introduction The Role of the Equity Portfolio Approaches to Equity Investing Passive Equity Investing Active Equity Investing Semi-Active Equity Investing Managing a Portfolio of Managers Identifying Selecting and Contracting with Equity Portfolio Mangers Structuring Equity Research and Security Selection www.ift.world 2 The Role of the Equity Portfolio • Equity represents a significant source of wealth • Equity can be found in both individual and institutional portfolios • Investing across multiple markets offers diversification benefits • Equities offer superior protection against unanticipated inflation • High historical long term rates of return www.ift.world 3 Approaches to Equity Investment • Passive Management – Investor does not attempt to reflect his investment expectations through changes in security holding – Equity market is efficient  indexing is the best strategy – Not really passive because portfolio needs to change when index is reconstituted or when weight of a stock changes because of corporate action • Active Management – Outperform benchmark portfolio by investing in underpriced securities – Dominant management style www.ift.world Approaches to Equity Investment • Semiactive Management – Also called enhanced indexing or risk-controlled active management – Variant of active management – Outperform benchmark but keep tracking risk in control www.ift.world Passive Equity Investing According to William Sharpe: 4.1 Equity Indices 4.2 Passive Investment Vehicles www.ift.world 4.1 Equity Indices Stock index’s characteristics are determined by Boundaries of stock index’s universe Criteria for inclusion How stocks are weighted How returns are calculated Listen to this lecture if you need a refresher on security market indices… http://www.youtube.com/watch?v=23qEK_mtMHo www.ift.world The S&P 500 also seeks to make sure the industry sectors in the S&P 500 represent the industries in the economy The sector percentages in the S&P 500 in 2010 were: Information Technology (17.8%), Financial (15.1%), Energy (12.7%), Industrials (11.3%), Consumer Staples (10.6%), Consumer Discretionary (10.6%), Materials (3.7%), Utilities (3.4%), Telecom Services (3.1%) (Source: S&P 500 Factsheet) To be included in the S&P 500, a company must meet the following minimum criteria: Be a U.S company Have a market cap of at least $4 billion At least 50% of its stock must be held by the public Four consecutive quarters of positive earnings A stock price of at least $1 per share Contribute to the overall balance of sectors within the S&P 500, to help it represent the overall market sector make-up Be listed on either the New York Stock Exchange or the NASDAQ Real Estate Investment Trusts (REITs) and business development companies can also be included The top 10 largest companies in the S&P 500 in 2011 were: Exxon Mobil, Apple, IBM, Chevron, General Electric, Microsoft, AT&T, Johnson & Johnson, Procter & Gamble and Pfizer The market cap of these 10 companies represent 20% of the market cap of the total S&P 500 http://useconomy.about.com/od/glossary/g/SP500.htm www.ift.world Price Weighted Value Weighted Each stock weighted Each stock weighted according to absolute share according to market cap price Float-weighted Biased towards highest Biased towards high price share market-cap stocks  large companies, overvalued Effectively investing in stocks proportion to share price Simple to construct DJIA is the most prominent example Suggestion: adjust component weights based on fundamentals (such as P/E) www.ift.world Equal Weighted All stocks treated the same Small company bias because such indices include many more small companies Requires frequent rebalancing www.ift.world 10 www.ift.world 65 www.ift.world 66 True/misfit distinction has two main uses: Performance appraisal Optimizing portfolio of managers www.ift.world 67 7.2 Completeness Fund • The completeness fund is a simpler strategy to manage overall portfolio risk and return • A manager may want to incorporate specific views with respect to the benchmark creating active return, however, the risk also goes up • The manager then identifies a basket or a number of trades which complete the fund, i.e minimize the active risk of the portfolio www.ift.world 68 7.3 Other Approaches: Alpha and Beta Separation www.ift.world 69 Identifying, Selecting and Contracting with Equity Portfolio Managers • Developing a universe of suitable manager candidates • The predictive power of past performance www.ift.world 70 Ad Valorem Fees Performance-Based Fees Percentage of assets under management (AUM) Typically a combination of base fee plus sharing percentage Also called AUM fees 0.2% of AUM plus 20% of performance in excess of benchmark 0.6% of first $50 mil 0.4% above that Simple and predictable Fee Structure Can include features like: Fee Cap High Water Mark Needs precise definition Call option to the investment manager www.ift.world 71 Equity Manager Questionnaire www.ift.world 72 www.ift.world 73 Structuring Equity Research and Security Selection • Top-down versus bottom up approaches • Buy-side versus sell-side research • Industry classification www.ift.world 74 Top Down and Bottom Up Analysis Top Down: Country  Industry  Security Selection Bottom Up: Focus on security selection www.ift.world 75 www.ift.world 76 Buy-Side versus Sell-Side Research • Buy Side: Research with intent of assembling a portfolio – Might use sell-side research – Typically committee decisions • Sell Side: Independent researchers who sell their work or investment banks/brokerage firms which use research as a means to generate business www.ift.world 77 Industry Classification Global Industry Classification Standard (GICS) developed by Standard and Poor’s and MCSI www.ift.world 78 Conclusion • Learning objectives • Summary • Examples • Practice Problems www.ift.world 79 ...Contents – Equity Portfolio Management Introduction The Role of the Equity Portfolio Approaches to Equity Investing Passive Equity Investing Active Equity Investing Semi-Active Equity Investing... Managing a Portfolio of Managers Identifying Selecting and Contracting with Equity Portfolio Mangers Structuring Equity Research and Security Selection www.ift.world 2 The Role of the Equity Portfolio. .. Dominant management style www.ift.world Approaches to Equity Investment • Semiactive Management – Also called enhanced indexing or risk-controlled active management – Variant of active management