porfolio mgt
TRANSCRIPT
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Introduction to Active
Portfolio Management
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Equity Style Spectrum
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Deep Value
Value GARP
Index
Growth
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Management Styles
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Traditionally:
Fundamental
An investment approach that relies on detailed
company specific research to identify buy/sellcandidates
Quantitative
An investment approach that relies on models
(involving forecasting financial metrics usingmathematical and statistical techniques) to identify
buy/sell candidates
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Decision Making Process
Fundamental vs. Quantitative
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Fundamental
Decisions based on human judgement
Applied depth and breath of knowledge to a narrow setof investment opportunities
Company visits may be important in the investment
process
Intellectual capital of managers very important Portfolio results less easily back-tested and replicated
Hard to test the investment strategy because it cannot be
quantified
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Decision Making Process
Discretionary vs Quantitative
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Quantitative
Based on objective rules: Relationship between
inputs (fundamental or technical/statistical factors)
and expected return are formalized in a model
Applied narrow set of information to broad set of
investment opportunities
More easily back-tested and replicated (if you knowthe model)
Intellectual capital of managers less important
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Overall Process
Investment Universe
Focus List
PortfolioConstruction
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Investment Process
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Investment universe
Dictated by strategy mandate. Examples: U.S. small
cap., global value, international growth
Focus list
Narrow down the universe and perform in-depth
research on stocks on the focus list
Portfolio construction Optimal weight of each stock in the final portfolio, risk
management
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Discretionary Managers
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Example: McLean Budden
Team-based majority voting Approach
Fundamental research
Active corporate interview program
Management process: see handout
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Quantitative Managers
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Example: LSV Asset Management
Use both statistical and fundamental inputs
Management process: see handout
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Basic Investment Strategies
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Top-down
Bottom-up
Value
Growth
GARP
Market cap
International
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Top-down Strategy
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Start with forecast of the economy: GDP growth,interest rates, exchange rates, capital flows,
employment growth.etc.
Then select industries that will prosper in theforecasted economic environment
Then select companies in the chosen industries,
based on financial analysis
Asset allocation funds are examples of top-downstrategy
Portfolio weights of two (or more) asset classes vary
over time, depending on market conditions
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Bottom-up Strategy
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Focus on the financial characteristics of individualcompanies
Start with preliminary screening based on financial
analysis, e.g., dividend yield > 2.5%, P/B < 2.5x,consistent sales growth .etc.
More in-depth company analysis of the stocks left inthe universe after screening
Managers with a specific mandate, e.g., value,growth, incomeetc. tend to be bottom-upmanagers
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Value Investing
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Choosing companies for which analysis reveals
unrecognized value
Company experienced profits and stock price
decline Stock underpriced by the market relative to its long-
term fundamentals
Value stocks tend to have high dividend yield, low
P/B, P/E, and P/cash flow
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Value Investing
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Which?
Long-term
earnings potential?
Profits and stock
price decline
Did investors over-react to short-term negative events?
Investment decision
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Value Investing (Contd)
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Graham and Dodds 1934 classic, Security Analysis,
published during the Great Depression
Warren Buffet was a student of Ben Graham at Columbia
University
But old ratios no longer apply in todays market (e.g.,
P/B < 2/3x. Now, 2x is considered low)
New value rules have been proposed by various authors Value trap: low price stock value stock
Momentum factor is important here
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Value Investing
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Discretionary/fundamental
For example, in The Warren Buffett Way by
Hagstrom (2005):
Business tenets Management tenets
Financial tenets (ROE, profit margin, debt etc.)
Value tenets (PV of cash flow)
Quantitative LSV (uses both fundamental and statistical inputs)
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Growth Investing
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Picking companies that are considered to haveabove average growth prospects
Higher than average valuation (P/B, P/E, P/cash flow)
Stock expected to generate above-average sales andearnings growth relative to its industry, or theoverall market
Growth stocks usually pay little or no dividend,excess cash used to finance expansion
Investors expect superior rate of stock priceappreciation, rather than dividend yield
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Value vs Growth
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Historically, value tends to outperform growth
Positive value premium over the long term
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Growth vs Value
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Value vs. Growth
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Blend
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Canadian stock market not large enough to have a
deep value or uniquely high growth portfolio
Equity funds can be a blended fund (mix of value
and growth stocks)
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Market Cap
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Specialize in a particular size
U.S. dollars (pre-2008 Q4):
Large cap: > $10 billion
Mid cap: $2 - $10 billion Small cap: $300 million - $2 billion
Micro cap: $50 - $300 million
Nano cap: Under $50 million
Size premium preference for small-mid cap tilt? Ifpassive, can pick a small-mid cap ETF
If active, may argue that this is the segment of themarket where manager can exploit inefficiencies
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International
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Country selection weakening as a source of alpha and
diversification
Economies and stock markets are increasinglyglobally integrated
New direction: sector selection
Sector calls made independent of geography
Benchmarks: EAFE (for developed markets), MSCI
World (for global markets)
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Currency Overlay
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Managing currency risk of international portfolio
separately. Equity managers job not affected
Can be active currency bets, or passive hedge
Whether or not to hedge depends on investmenthorizon, and faith in the PPP
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Impact of Currency
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