1. Fin 2802: Investments Spring, 2010 Dragon Tang
Lecture 19
Practical Portfolio Management
April 8, 2010
Readings: Chapter 27
Practice Problem Sets: 1,2
Chapter 27: Practical Portfolio Management
FIN 2802, Spring 10 - Tang

2. Chapter 27: Practical Portfolio Management
Overview
Treynor-Black model
Optimization using analysts’ forecasts of superior performance
Adjusting model for tracking error
Adjusting model for analyst forecast error
Black-Litterman model
Chapter 27: Practical Portfolio Management
FIN 2802, Spring 10 - Tang

3. Chapter 27: Practical Portfolio Management
Table 27.1 Construction and Properties of the Optimal Risky Portfolio (properties 1-5)
Chapter 27: Practical Portfolio Management
FIN 2802, Spring 10 - Tang

4. Chapter 27: Practical Portfolio Management
Table 27.1 Construction and Properties of the Optimal Risky Portfolio (properties 6-11)
Chapter 27: Practical Portfolio Management
FIN 2802, Spring 10 - Tang

5. Table 27.2 Stock Prices and Analysts’ Target Prices for June 1, 2006
Chapter 27: Practical Portfolio Management
FIN 2802, Spring 10 - Tang

6. Chapter 27: Practical Portfolio Management
Figure 27.1 Rates of Return on the S&P 500 (GSPC) and the Six Stocks June 2005 – May 2006
Chapter 27: Practical Portfolio Management
FIN 2802, Spring 10 - Tang

7. Chapter 27: Practical Portfolio Management
Table 27.3 The Optimal Risky Portfolio with the Analysts’ New Forecasts
Chapter 27: Practical Portfolio Management
FIN 2802, Spring 10 - Tang

8. Chapter 27: Practical Portfolio Management
Table 27.4 The Optimal Risk Portfolio with Constraint on the Active Portfolio (WA < 1)
Chapter 27: Practical Portfolio Management
FIN 2802, Spring 10 - Tang

9. Figure 27.2 Reduced Efficiency when Benchmark Is Lowered
Chapter 27: Practical Portfolio Management
FIN 2802, Spring 10 - Tang

10. Chapter 27: Practical Portfolio Management
Table 27.5 The Optimal Risky Portfolio with the Analysts’ New Forecasts (benchmark risk constrained to 3.85%)
Chapter 27: Practical Portfolio Management
FIN 2802, Spring 10 - Tang

11. Figure 27.3 Histogram of the Alpha Forecast
Chapter 27: Practical Portfolio Management
FIN 2802, Spring 10 - Tang

12. Figure 27.4 Organizational Chart for Portfolio Management
Chapter 27: Practical Portfolio Management
FIN 2802, Spring 10 - Tang

13. Steps in the Black-Litterman Model
Step 1: Estimate the covariance matrix from historical data
Step 2: Determine a baseline forecast
Step 3: Integrating the manager’s private views
Step 4: Developing revised (posterior) expectations
Step 5: Apply portfolio optimization
Chapter 27: Practical Portfolio Management
FIN 2802, Spring 10 - Tang

14. Chapter 27: Practical Portfolio Management
Figure 27.5 Sensitivity of Black Litterman Portfolio Performance to Confidence Level (view is correct)
Chapter 27: Practical Portfolio Management
FIN 2802, Spring 10 - Tang

15. Chapter 27: Practical Portfolio Management
Figure 27.6 Sensitivity of Black Litterman Portfolio Performance to Confidence Level (view is false)
Chapter 27: Practical Portfolio Management
FIN 2802, Spring 10 - Tang

16. Table 27.6 M-Square for the Portfolio, Actual Forecasts
Chapter 27: Practical Portfolio Management
FIN 2802, Spring 10 - Tang

17. Table 27.7 M-Square for the Simulated Portfolios
Chapter 27: Practical Portfolio Management
FIN 2802, Spring 10 - Tang

18. Concluding Remarks on the Theory of Active Investments
The gap between theory and practice has been narrowing in recent years
The CFA is expanding knowledge base in the industry
Specific lack of application of the Treynor-Black model may be related to lack of application of adjusting for analysts’ errors
Chapter 27: Practical Portfolio Management
FIN 2802, Spring 10 - Tang

19. Chapter 27: Practical Portfolio Management
Summary
Treynor-Black model
Black-Litterman Model
Next Class: Performance Evaluation
Chapter 27: Practical Portfolio Management
FIN 2802, Spring 10 - Tang