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MIS 4500 (31)

Chapter 32.docx

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Management Info. Systems
MIS 4500
Pourang Irani

Chapter 32: Equity Portfolio Management  Role of the Equity Portfolio o inflation hedge: if returns are sufficient on average to preserve purchasing power during periods of inflation  superior protection for unanticipated inflation than nominal bonds o long-term portfolio growth Approaches to Equity Investment:  passive, active, semiactive: o Semiactive (aka enhanced indexing and risk-controlled active management): tracking risk watched o Information ratio = mean active return / tracking risk Passive Equity Investing:  Equity Indices: o Index Weighting Choices:  Price Weighting: according to absolute share price; performance represented by one share (as adjusted for splits) of each index component; biased toward highest priced share  Value weighted (or market-capitalization weighted): weighted according to market cap; performance represents owning all outstanding shares of index components; biased toward highest market cap  float-weighted index: not all, but all of the free float (principal S&P funds are float weighted)  Equal weighted: say $1000 in each index component; require periodic rebalancing; small company bias o Composition and Characteristics of Major Indices:  most major are float-weighted  DJIA is price weighted  Passive Investment Vehicles: o Indexed portfolios: 1. conventional index mutual funds; 2. ETFs; 3. separate or pooled accounts  separate or pooled accounts are extremely low-cost products (may be able to cover costs by security lending)  4 differences b/w ETFs and mutual funds:  1. shareholder accounting at mutual fund level and expensive; none for ETFs  2. ETFs pay higher index license fees  3. ETFs more tax efficient: in kind redemptions  4. ETFs pay transaction costs to trade but better protected w/ liquidity  full replication: say if fewer than 1000 stocks: costs that cause differences from index:  cost of managing and administering fund  transaction costs of adjustments to reflect changes in index composition  transaction costs of investing and disinvesting cash flows  drag from cash positions while market is upward trending  stratified sampling (aka representative sampling): 1. divide index along multiple dimensions (create multidimensional cells); 2. determine weight of each cell; 3. take random sample from w/i cells and weight according to cell weight; consider diversification reqs;  optimization: use multifactor risk model of index and individual securities, and function to minimize tracking risk; factors may be market cap, beta, industry, macro etc.  accounts for covariances (stratified sampling does not)  model risk  overfitting data  requires periodic trading o Equity Index Futures: use stock index futures; delivery involves portfolio trades / program trades / basket trades  consider uptick rules o Equity Total Return Swaps:  application has been curtailed by U.S. tax law changes (constructive sales?)  tax-oriented applications focus primarily on differences in tax treatment accorded domestic and int’l recipients of corporate dividends (withholding taxes)  may save costs in case of rebalancing portfolio (tactical allocation) Active Equity Investing:  Equity Styles: o value: focus on purchasing at low P/E  say b/c of mean reversion  may be cheap for good economic reasons  low P/E style: usually found in defensive, cyclical and simply out of favor  contrarian style: look for stocks that have been beset by problems (P/B < 1); in depressed industries; buy when expected rebound  high yield style: purchase w/ high and growing dividend yield o growth: focus on selecting high-earnings-growth cos  industries include: technology, health care, consumer products  consistent growth style: long history of unit-sales growth, superior profitability and predictable earnings  relative strength indicators: compare stock’s performance during specific period to past performance or performance of group  earnings momentum style: bet on continual high earnings growth o Other active management styles:  market oriented (aka blend or core): intermediate grouping; buy stocks based on intrinsic value regardless of whether value or growth; tends to resemble broad-market equity index  w/ value bias: almost value style  w/ growth bias: almost growth style  growth-at-a-reasonable price: above avg growth prospects selling at conservative valuations (not as diversified as straight growth style)  style rotators: invest in style that will be favored in the near term  small cap style / micro cap style (underresearched, or better growth prospects)  mid cap (underresearched but stronger than micro caps)  large cap: emphasis on superior analysis and insight o Technique for identifying investment styles:  returns-based style analysis on portfolio returns (RBSA): regress realized returns on return series for set of securities indices (set must be mutually exclusive, exhaustive and risk distinct); betas set to total 1.  the weights set the “normal portfolio/benchmark”  1 minus style fit equals selection  error term represents selection return  holdings-based style analysis (aka composition-based style analysis): categorize individual securities by characteristics and aggregate results; evaluate:  valuation levels  forecast EPS growth rate  earnings variability: (greater would be indicative of value-oriented)  industry sector weightings: value-oriented would have financing
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