1. Equity Portfolio Management MIP, Chapter 7 Kevin C.H. Chiang

2. Approached to equity investment Passive management – The dominant approach is indexing Active management – Seeks to outperform a given benchmark – By overweighting those stocks that deem promising and underweighting those stocks that deem less promising

3. Active return Active return: the differences between fund returns and benchmark returns. The goal of active management is try to generate consistent positive active returns (holding other factors constant, higher the better).

4. Tracking ratio and information ratio Tracking risk: the standard deviation of active returns (the lower the better). Information ratio: the ratio of mean active return to tracking risk (the higher the better). Some sponsors impose expectations on managers’ tracking risk and information ratio.

5. Popular equity indices Exhibit 7-10, pp. 420-421.

6. Investment style Investment style: a natural grouping of investment disciplines that has some predictive power in explaining the future dispersion of portfolio/fund returns across portfolios/funds. Why one particular style? (1) Drives fund risk and fund return, (2) allows research to be more focused, (3) aligns with research strengths and philosophy, (4) fund/plan sponsors often requires style specialization.

7. Value style vs. growth style Value style: investing in high value/price (low price/value) stocks; e.g., high B/M stocks, low P/E stocks. – A stylized value premium. – At least 3 sub-styles: low P/E, contrarian, and high yield. Growth style: investing in low value/price (high value/price) stocks. – The most popular style among mutual funds. – At least 2 sub-styles: consistent growth (a long- history of sales growth, superior earnings), and earnings momentum.

8. Big-cap style vs. small-cap style Used to have a small-cap premium. Small-cap style can impose liquidity/depth risk on large funds.

9. Techniques for identifying styles 1 st category: return-based methods, such as regressions or Sharpe’s style analysis (a special form of regression). – An example of rolling style chart, Exhibit 7-13, p. 439) 2 nd category: holdings-based analysis. – Look into actual stock holdings. – Morningstar uses this method to construct its 3×3 style box for funds (Exhibit 7-18, p.448).

10. Style drift Drift: inconsistency in investment style over time. An obstacle to investment planning and risk management from fund/plan sponsors’ perspectives. Fund/plan sponsors usually monitor for signs of style drift; managers may need to explain for it.

11. SRI Socially responsible investing: one can consider this to be a special style. Some fund/plan sponsors today have an SRI mandate. Some fund/plan sponsors worry that an SRI mandate will reduce diversification benefits.

12. Screening Screening based on some criteria reflecting investing style and philosophy, e.g., P/E, earnings momentum, etc., is often used by research units so that there is focus and efficiency in research.

13. Structuring research Top-down: focus research on macroeconomic/industrial factors or investment themes. The stock holdings in top-down investors’ portfolios reflect their macro insights. Bottom-up: have little interest in the state of the economy or other macro factors, but rather try to put together the best portfolio of stocks based on company-specific information.

14. Sell-side vs. buy-side research Sell-side research is generally organized by sector/industry with a regional delineation; e.g., a U.S. banking analyst. Buy-side research: mainly concerned with assembling a portfolio, so decisions on buy- side research are usually made through a committee structure. – These research reports/essays are not available to outsiders.