Professional Documents
Culture Documents
to accompany
Chapter 22
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Full Replication
All securities in the index are purchased in proportion to weights in the index This helps ensure close tracking Increases transaction costs, particularly with dividend reinvestment
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Sampling
Buys a representative sample of stocks in the benchmark index according to their weights in the index Fewer stocks means lower commissions Reinvestment of dividends is less difficult Will not track the index as closely, so there will be some tracking error
Expected Tracking Error Between the S&P 500 Index and Portfolio Samples of Less Than 500 Stocks
Expected Tracking Error (Percent) 4.0 3.0 2.0 1.0 500 400 300 200 100 0
Figure 22.1
Number of Stocks
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Completeness Funds
Passive portfolio customized to complement active portfolios which do not cover the entire market Performance compared to a specialized benchmark that incorporates the characteristics of stocks not covered by the active managers
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Three Strategies
Market timing - shifting funds into and out of stocks, bonds, and T-bills depending on broad market forecasts and estimated risk premiums Shifting funds among different equity sectors and industries or among investment styles to catch hot concepts before the market does Stockpicking - individual issues
Global Investing
Identify countries with markets undervalued or overvalued and weight the portfolio accordingly Manage the global portfolio from an industry perspective rather than from a country perspective Focus on global economic trends, industry competitive forces, and company strengths and strategies
Sector Rotation
Position a portfolio to take advantage of the markets next move Screening can be based on various stock characteristics:
Value Growth P/E Capitalization Sensitivity to economic variables
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Style
Construct a portfolio to capture one or more of the characteristics of equity securities Small-capitalization stocks, low-P/E stocks, etc Value stocks appear to be underpriced
price/book or price/earnings
Determining Style
Style grid:
firm size value-growth characteristics
Style analysis
constrained least squares
Benchmark Portfolios
Sharpe
T-bills, intermediate-term government bonds, long-term government bonds, corporate bonds, mortgage related securities, large-capitalization value stocks, large-capitalization growth stocks, medium-capitalization stocks, smallcapitalization stocks, non-U.S. bonds, European stocks, and Japanese stocks
Benchmark Portfolios
Sharpe BARRA
Uses portfolios formed around 13 different security characteristics, including variability in markets, past firm success, firm size, trading activity, growth orientation, earnings-to-price ratio, book-to-price ratio, earnings variability, financial leverage, foreign income, labor intensity, yield, and low capitalization
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Benchmark Portfolios
Sharpe BARRA Ibbotson Associates
simplest style model uses portfolios formed around five different characteristics: cash (Tbills), large-capitalization growth, smallcapitalization growth, large-capitalization value, and small-capitalization value
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Using Futures in
Passive Equity Portfolio Management
Help manage cash inflows and outflows while still tracking the target index Options can be sold to reduce weightings in sectors or individual stocks during rebalancing
End of Chapter 22
Equity Portfolio Management Strategies