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Administrative Studies
ADMS 4501
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Advanced Portfolio Management ADMS 4501 – Winter 2012 – Lois King Lecture 11 – Chapter 15 – Equity P/M Strategies – Mar 22 An Overview - Passive investment management o Long-term buy-and-hold strategy. o Usually tracks and index over time. o Designed to match market performance. o Manager is judged on how well they track the target index. - Active equity portfolio management o Attempts to outperform a passive benchmark portfolio on a risk-adjusted basis by seeking the ‘alpha’ value. Passive Equity Portfolio Management Strategies - Attempt to replicate the performance of an index. o May slightly underperform the target index due to fees and commissions. - Strong rationale for this approach. o Costs of active management (1 to 2%) are hard to overcome in risk- adjusted performance. - Many different market indexes are used for tracking portfolios. Index Portfolio Construction Techniques - Full replication o All securities in the index are purchased in proportion to weights in the index. o This helps ensure close tracking. o Increases transaction costs, particularly with dividend reinvestment. - Sampling o Buys a representative sample of stocks in the benchmark index according to their weights in the index. o Fewer stocks means lower commissions. o Reinvestment of dividends is less difficult. o Will not track the index as closely, so there will be some tracking error. - Quadratic optimization (or programming techniques) o Historical information on price changes and correlations between securities are input into a computer program that determines the composition of a portfolio that will minimize tracking error with the benchmark. o Relies on historical correlations, which may change over time, leading to failure to track the index. Tracking Error and Index Portfolio Construction - The goal of the passive manager should be to minimize the portfolio’s return volatility relative to the index, i.e. to minimize tracking error. Methods of Index Portfolio Investing - Index fund o In an indexed portfolio, the fund manager will typically attempt to replicate the composition of the particular index exactly or through sampling. o Change those positions anytime the composition of the index itself is changed. o Low trading and management expense ratios. o Advantage: provide an inexpensive way for investors to acquire a diversified portfolio. - ETFs o Depository receipts that give investors a pro rata claim on the capital gains and cash flows of the securities that are held in deposit by a financial institution that issued the certificates. o One big advantage of ETFs over index mutual funds is that they can be bought and sold (and short sold) like common stock. Active Equity Portfolio Management Strategies - Goal is to earn a portfolio return that exceeds the return of a passive benchmark portfolio, net of transaction costs, on a risk-adjusted basis (‘alpha’). o Need to select an appropriate benchmark. - Practical difficulties of active manager. o Transactions costs must be offset by superior performance vis-à-vis the benchmark. o Higher risk-taking can also increase needed performance to beat the benchmark. Active Portfolio Management – Fundamental Strategies - Top-dow
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