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    Introduction to Active

    Portfolio Management

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    Equity Style Spectrum

    11/16/20122

    Deep Value

    Value GARP

    Index

    Growth

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    Management Styles

    11/16/20123

    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

    11/16/20124

    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

    11/16/20125

    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

    11/16/20126

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    Investment Process

    11/16/20127

    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

    11/16/20128

    Example: McLean Budden

    Team-based majority voting Approach

    Fundamental research

    Active corporate interview program

    Management process: see handout

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    Quantitative Managers

    11/16/20129

    Example: LSV Asset Management

    Use both statistical and fundamental inputs

    Management process: see handout

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    Basic Investment Strategies

    11/16/201210

    Top-down

    Bottom-up

    Value

    Growth

    GARP

    Market cap

    International

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    Top-down Strategy

    11/16/201211

    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

    11/16/201212

    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

    11/16/201213

    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

    11/16/201214

    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)

    11/16/201215

    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

    11/16/201216

    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

    11/16/201217

    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

    11/16/201218

    Historically, value tends to outperform growth

    Positive value premium over the long term

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    Growth vs Value

    11/16/201219

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    Value vs. Growth

    11/16/201220

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    Blend

    11/16/201222

    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

    11/16/201223

    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

    11/16/201224

    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

    11/16/201225

    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

    11/16/201226