Portfolio Management Revisited Guancheng Li

Passive Management vs Active Management Line in this book: whether action is predicated on forecast data. the line between passive and active management becomes increasingly fuzzy

Stock Portfolios Passive Management Simplest case: replicate exactly a well-defined index of common stock The problem trade-off between accuracy in duplicating the index and transaction costs Solutions 1.Hold each stock in the proportion it represents of the index. 2.Form a portfolio of not more than a specified number of stocks 3.Find a smaller set of stocks that matches the index in the percentage invested in a pre- specified set of characteristics

Stock Portfolios Passive Management some low-cost funds have outperformed the index they match over long periods of time. S&P occasionally missed small stock dividends in calculating the return index funds always deliver stock when a firm offers to buy it above market price innovations uses temporary mispricing across types of markets to increase the return switch back and forth between the cash and futures markets to take advantage of any temporary mispricing that might arise between the two markets.

Stock Portfolios Active Management hold each stock in the proportion it represents of the index Any difference from these proportions represents a bet based on a forecast. it useful to divide active managers into three groups Market timers sector selectors security selectors.

Stock Portfolios Active Management security selectors. search for undervalued securities and the methods of forming these securities into optimum portfolios sector rotation like security selection, except that the unit of interest is an industry or a sector Market timers change the beta on the overall portfolio, either by changing the beta on the equity portfolio or by changing the amount invested in short-term bonds market timing in stocks is used far less frequently than market timing decisions in managing bond portfolios

Stock Portfolios Active Management The predictive content of forecasts used in active management must be sufficiently large to overcome the following costs The cost of paying the forecasters The cost of diversifiable risk. The cost of higher transaction cost. For the taxable investor, an early incidence of capital gains tax.

INTERNATIONAL DIVERSIFICATION international portfolio diversification is potential First，decide whether to hold a passive portfolio of individual countries Second, decide whether to bear the potential benefits and risk of currency movements or to hedge away changes in the relative value of currencies. Finaly, decide whether to actively or passively manage the portfolio of stocks within each country. Any of the models discussed to this point can be applied within each country.

Bond Management Passive Strategies Buy units that investor trusted(such as municipal bonds. ) BOND index are hard to match changing nature of the index many bond indexes contain bonds that are illiquid bonds can be bought in only large denominations (small cost are high)

Bond Management Active Strategies Same as Stock Management Market timing An estimate is made of what will happen to interest rates If interest rates are expected to rise, prices are expected to fall, and capital losses will be incurred on bonds. If a manager believes that interest rates will rise, and other investors share this belief, then market prices will reflect this expectation. pursue the risk premium associated with lower-rated bonds.

Bond And Stock Investment with a Liability stream Many portfolio managers are in charge of investing funds that are provided to meet future obligations insurance pension funds Awareness the accounting treatment of the return on pension assets has changed regulatory bodies concerned with financial intermediaries have forced the intermediaries to value more of their assets and liabilities at the price they would get if sold rather than at original cost. in the 1980s, many companies found that certain investment strategies, such as cash flow matching or dedication, resulted in surplus pension assets,

Bond And Stock Investment with a Liability stream assume that the liability stream is known and fixed An exact cash flow–matched portfolio employing only noncallable default-free (government) debt would have zero risk allow cash to be transferred between periods at a set rate. This is an assumed rate, and to the extent that it does not materialize, liabilities will not be matched. introduce higher expected return debt into the portfolio assume that the liability stream is a function of one or more exogenous influences. With the two-factor model, the manager can choose to eliminate the exposure to any factor by making the net exposure to that factor zero.Should a manager eliminate factor risk? To answer this question, consider two different scenarios. First, consider that the factor is unpriced so that exposure does not affect expected return in equilibrium. Second, consider that the factors are priced in the sense that exposure increases expected return.

Bond Stock mixed managers who use fairly stable proportions through time characteristics of various asset classes (e.g., mean return, variance) are fairly constant over time simulation is frequently used to examine the characteristics of the return distributions for different mixes over several different time spans managers who actively vary their proportions over time. varying mixes over time tactical asset allocation, forecast the relative performance