Stock-Trak Report

4 pages

1. Follow the Stock-Track Report Guide(FOLLOW EVERY STEP)

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2. Use the Investment Policy Statement(IPS) to write

3. Ues mt Stock-Track MOVE to write

Investment Policy Statement (IPS)

This portfolio is designed for an individual investor who is 22 years old and has a portfolio with the aim of maximizing return. The investor has a moderately aggressive tolerance for risk. The investment is using an appropriate variety set of objectives and goals to be attained through the investment of the portfolio’s assets. The primary goal entails long term growth focused on price appreciation, whereas secondary objective includes total return strategy through interest and dividend income. For worst case scenario, one year’s loss limit should be controlled within 20%.

The portfolio will reach an annual total return of 10% based on a 3-year statistical data of return. The portfolio with allocation of assets is diversified with different classes of financial assets to reduce business risk. The portfolio has average 1.2 which indicates the stocks’ price swings more wildly than most stocks. Financial assets include 80% stock, 10% bonds, and 10% cash. Other portfolio assets include mutual funds, options, futures, equities, and exchange-traded funds. The portfolio will be rebalanced annually at the beginning of each financial year when an asset becomes inefficient relative to its peers. The portfolio will be rebalanced annually at the beginning of each financial year when an asset becomes inefficient relative to its peers. The benchmarking peers include 25% Barclays Agg Total Bond Market TR, 5% three-month T-bill, and 70% S & P 500 Index TR.

In a nutshell, the investment portfolio is diversified to achieve the financial goals of the moderately aggressive risk-tolerant investor. The investor aims to maximize return through mutual funds, options, futures, equities, and exchange-traded funds. The portfolio manager is going to rebalance portfolio annually at the beginning of each financial year when an asset becomes inefficient relative to its peers.

Stock-Trak Portfolio Report Write-Up Guidelines

You may want to follow the guidelines below for the final report of your Stock-Trak portfolio performance during the quarter. Your report is not expected to exceed four pages excluding any tables and appendices.

1. On the first page, replicate the investment policy statement (IPS) including your asset allocation that you submitted to the instructor.

2. Explain the funds allocation among different assets that you actually choose in your Stock-Trak portfolio. If your actual asset allocation is different from the allocation in your policy statement, explain the rationale for changing your asset allocations. Here you may think of strategic asset allocation and tactical asset allocation strategies that we discussed in chapter 11.

3. Provide your rationale for selecting the particular securities such as stock, mutual funds, ETFs, bonds, bond funds, real estate funds, etc. for your Stock-Trak portfolio. That is, explain why you considered these securities to be the most suitable in meeting your return-risk goals and asset allocations in the investment policy statement. You may use the portfolio investment philosophies and strategies from chapter 16 such as passive strategies, indexing, top-down approach, style-based strategies, asset attributes-based strategies, and technical analysis in your explanation (see chapter 11 and Exhibit 11.6).

4. Compare the performance of your portfolio relative to a relevant benchmark you stated in your policy statement. If you did not list a benchmark in your IPS, you may use a broader well-known benchmark such as S&P 500 or NADAQ composite, or create and use a hybrid benchmark of stock and bond markets (weighted average of the returns of a stock market index and bond market index).

5. Describe what worked and what did not work in your Stok-Trak portfolio? Explain what mistakes you made and what lessons did you learn from the Stock-Trak portfolio simulation? If you would have to redo this portfolio investment with your actual money or money from your investment clients, what you would do differently in managing such real money portfolios?

CHAPTER

Equity Portfolio
Management Strategies

11.1 Passive versus Active Management

Equity portfolio management strategies can be placed into either a passive or an active category

One way to distinguish between these strategies is to decompose the total actual return that the portfolio manager attempts to produce:

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11.1 Passive versus Active Management (slide 2 of 3)
Passive equity portfolio management
Long-term buy-and-hold strategy
Usually tracks an index over time
Designed to match market performance
Manager is judged on how well they track the target index
Active equity portfolio management
Attempts to outperform a passive benchmark portfolio on a risk-adjusted basis by seeking the “alpha” value
Exhibit 11.1

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11.1 Passive versus Active Management (slide 3 of 3)

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11.2 An Overview of Passive Equity Portfolio Management Strategies
Attempt to replicate the performance of an index
May slightly underperform the target index due to fees and commissions
Strong rationale for this approach
Costs of active management (1 to 2 percent) are hard to overcome in risk-adjusted performance
Many different market indexes are used for tracking portfolios
S&P 500 Index
NASDAQ Composite Index

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11.2.1 Index Portfolio Construction Techniques
There are three basic techniques for constructing a passive index portfolio:
Full replication
Sampling
Quadratic optimization

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11.2.1 Index Portfolio Construction Techniques (slide 2 of 5)
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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11.2.1 Index Portfolio Construction Techniques (slide 3 of 5)
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

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11.2.1 Index Portfolio Construction Techniques (slide 4 of 5)
Quadratic optimization (or programming techniques)
Historical information on price changes and correlations between securities are input into a computer program that determines the composition of a portfolio that will minimize tracking error with the benchmark
This relies on historical correlations, which may change over time, leading to failure to track the index

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11.2.1 Index Portfolio Construction Techniques (slide 5 of 5)
Completeness funds:
Constructed to complement active portfolios that do not cover the entire market
For example, a large pension fund may allocate some of its holdings to active managers expected to outperform the market
Many times, these active portfolios are overweighted in certain market sectors or stock types
In this case, the pension fund sponsor may want the remaining funds to be invested passively to “fill the holes” left vacant by the active managers

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11.2.2 Tracking Error and Index Portfolio Construction
The goal of the passive manager should be to minimize the portfolio’s return volatility relative to the index, i.e., to minimize tracking error
Tracking error measure
Return differential in time period t

Where
Rpt= return to the managed portfolio in Period t
Rbt= return to the benchmark portfolio in Period t
Tracking error is measured as the standard deviation of Δt , normally annualized (TE)
Exhibit 11.2

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11.2.2 Tracking Error and Index Portfolio Construction (slide 2 of 2)

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11.2.3 Methods of Index Portfolio Investing
Index Funds
In an indexed portfolio, the fund manager will typically attempt to replicate the composition of the particular index exactly
The fund manager will buy the exact securities comprising the index in their exact weights
Change those positions anytime the composition of the index itself is changed
Low trading and management expense ratios
The advantage of index mutual funds is that they provide an inexpensive way for investors to acquire a diversified portfolio

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11.2.3 Methods of Index Portfolio Investing (slide 2 of 4)
Exchange-Traded Funds (ETF)
ETFs are depository receipts that give investors a pro rata claim on the capital gains and cash flows of the securities that are held in deposit by a financial institution that issued the certificates
A significant advantage of ETFs over index mutual funds is that they can be bought and sold (and short sold) like common stock
The notable example of ETFs
Standard & Poor’s 500 Depository Receipts (SPDRs)
iShares
Sector ETFs
Exhibits 11.3, 11.4

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11.2.3 Methods of Index Portfolio Investing (slide 3 of 4)

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11.2.3 Methods of Index Portfolio Investing (slide 4 of 4)

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11.3 An Overview of Active Equity Portfolio Management Strategies
Goal is to earn a portfolio return that exceeds the return of a passive benchmark portfolio, net of transaction costs, on a risk-adjusted basis
Need to select an appropriate benchmark
Practical difficulties of active manager
Transactions costs must be offset by superior performance vis-à-vis the benchmark
Higher risk-taking can also increase needed performance to beat the benchmark
Exhibits 11.5 and 11.6

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11.3 An Overview of Active Equity Portfolio Management Strategies (slide 2 of 3)

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11.3 An Overview of Active Equity Portfolio Management Strategies (slide 3 of 3)

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11.3.1 Fundamental Strategies
Top-Down versus Bottom-Up Approaches
Top-Down
Broad country and asset class allocations
Sector allocation decisions
Individual securities selection
Bottom-Up
Emphasizes the selection of securities without any initial market or sector analysis
Form a portfolio of equities that can be purchased at a substantial discount to what his or her valuation model indicates they are worth

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11.3.1 Fundamental Strategies (slide 2 of 5)
Three generic themes
Time the equity market by shifting funds into and out of stocks, bonds, and T-bills depending on broad market forecasts
Shift funds among different equity sectors and industries (e.g., financial stocks, technology stocks) or among investment styles (e.g., value, growth large capitalization, small capitalization). This is basically the sector rotation strategy
Do stock picking and look at individual issues in an attempt to find undervalued stocks
Exhibits 11.7, 11.8

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11.3.1 Fundamental Strategies (slide 3 of 5)

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11.3.1 Fundamental Strategies (slide 4 of 5)

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11.3.1 Fundamental Strategies (slide 5 of 5)
The 130/30 Strategy
Long positions up to 130 percent of the portfolio’s original capital and short positions up to 30 percent
The use of the short positions creates the leverage needed, increasing both risk and expected returns compared to the fund’s benchmark
Enable managers to make full use of their fundamental research to buy stocks they identify as undervalued as well as short those that are overvalued

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11.3.2 Technical Strategies
Contrarian Investment Strategy
The belief that the best time to buy (sell) a stock is when the majority of other investors are the most bearish (bullish) about it
The concept of mean reverting (returns move back to mean return)
The overreaction hypothesis
Price Momentum Strategy
Focus on the trend of past prices alone and makes purchase and sale decisions accordingly
Assume that recent trends in past prices will continue
Exhibits 11.9, 11.10

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11.3.2 Technical Strategies (slide 2 of 3)

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11.3.2 Technical Strategies (slide 3 of 3)

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11.3.3 Factors, Attributes, and Anomalies
Factor-based investment strategy (FF 4/5 factors model)
The manager forms portfolios that emphasize certain characteristics of a collection of securities—such as firm size, relative valuation, low return volatility, momentum, or company quality—that are believed to produce higher risk-adjusted returns than those in a traditional benchmark that is weighted by the market capitalization of the stocks in the index
The risk premia associated with these characteristic-oriented portfolios—or factors, as they are called—allow the investor to earn superior returns with better diversification than holding a traditional passive index fund
Exhibits 11.11, 11.12

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11.3.3 Factors, Attributes, and Anomalies (slide 2 of 5)

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11.3.3 Factors, Attributes, and Anomalies (slide 3 of 5)

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11.3.3 Factors, Attributes, and Anomalies (slide 4 of 5)
Earnings Momentum Strategy
Momentum is measured by the difference of actual EPS to the expected EPS
Purchases stocks that have accelerating earnings and sells (or short sells) stocks with disappointing earnings
Calendar-Related Anomalies
The Weekend Effect
The January Effect
Firm-Specific Attributes
Firm Size (small vs. large firms)
P/E and P/BV ratios (value vs. growth firms)
Exhibit 11.13

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11.3.3 Factors, Attributes, and Anomalies (slide 5 of 5)

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11.3.5 Tax Efficiency and Active Equity Management
Active portfolio managers especially need to consider taxes when deciding whether to sell or hold a stock whose value has increased
If a security is sold at a profit, capital gains are paid and less in left in the portfolio to reinvest
A new security (the reinvestment security) needs to have a superior return sufficient to make up for these taxes
The size of the expected return depends on the expected holding period and the cost basis (and amount of the capital gain) of the original security

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11.3.5 Tax Efficiency and Active Equity Management (slide 2 of 3)
Measures of Tax Efficiency
Portfolio Turnover
Measured as the total dollar value of the securities sold from the portfolio in a year divided by the average dollar value of the assets

Where
PTR = pretax return
TAR = tax-adjusted return
See Exhibit 11.14

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11.3.5 Tax Efficiency and Active Equity Management (slide 3 of 3)

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11.3.6 Active Share and Measuring the Level of Active Management
A more direct way to assess how active a manager’s strategy is to look directly at the portfolio’s holdings compared to those in the benchmark
Cremers and Petajisto (2009) have suggested calculating the portfolio’s active share measure as:

Where:
[wp,i, wb,i] represent the investment weight of the ith security in the managed portfolio (p) and benchmark index (b), respectively

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11.3.6 Active Share and Measuring the Level of Active Management (slide 2 of 3)
Active share statistic
The percentage of security holdings in the manager’s portfolio that differ from those in the benchmark index
Exhibit 11.15

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11.3.6 Active Share and Measuring the Level of Active Management (slide 3 of 3)

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11.4 Value versus Growth Investing: A Closer Look
A growth investor focuses on the current and future economic growth “story” of a company, with less regard to share valuation (no attention to P/E)
A value investor focuses on share price in anticipation of a market correction and, possibly, improving company fundamentals.
Value stocks generally have offered somewhat higher returns than growth stocks, but this does not occur with much consistency from one investment period to another

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11.4 Value versus Growth Investing: A Closer Look (slide 2 of 7)
Growth-oriented investor will:
Focus on EPS and its economic determinants
Look for companies expected to have rapid EPS growth
Assumes constant P/E ratio
Value-oriented investor will:
Focus on the price component (Price vs. EPS)
Not care much about current earnings
Assume the P/E ratio is below its natural level
Exhibits 11.16, 11.17, 11.18, 11.19, 11.20

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11.4 Value versus Growth Investing: A Closer Look (slide 3 of 7)

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11.4 Value versus Growth Investing: A Closer Look (slide 4 of 7)

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11.4 Value versus Growth Investing: A Closer Look (slide 5 of 7)

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11.4 Value versus Growth Investing: A Closer Look (slide 6 of 7)

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11.4 Value versus Growth Investing: A Closer Look (slide 7 of 7)

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11.5 An Overview of Style Analysis
Style analysis:
Attempts to explain the variability in the observed returns to a security portfolio in terms of the movements in the returns to a series of benchmark portfolios capturing the essence of a particular security characteristic
Determines the combination of long positions in a collection of passive indexes that best mimics the past performance of a security portfolio
A simple style grid could be used to classify a manager’s performance along two dimensions: firm size (large cap, mid cap, small cap) and relative value (value, blend, growth) characteristics

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11.5 An Overview of Style Analysis (slide 2 of 5)
Formally, style analysis relies on the constrained least squares procedure, with the returns to the manager’s portfolio as the dependent variable and the returns to the style index portfolios as the independent variables
There are often three constraints employed:
No intercept term is specified
The coefficients must sum to one
All the coefficients must be nonnegative
Exhibits 11.21, 11.22, 11.23

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11.5 An Overview of Style Analysis (slide 3 of 5)

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11.5 An Overview of Style Analysis (slide 4 of 5)

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11.5 An Overview of Style Analysis (slide 5 of 5)

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11.6 Asset Allocation Strategies
An equity portfolio does not stand in isolation; it is part of an investor’s overall investment portfolio
The portfolio manager must consider the appropriate mix of asset categories in the entire portfolio
There are four general strategies for determining the asset mix of a portfolio

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11.6.1 Integrated Asset Allocation
The integrated asset allocation strategy separately examines:
Capital market conditions
Investor’s objectives and constraints
These factors are combined to establish the portfolio asset mix that offers the best opportunity for meeting the investor’s needs
Continuously adjust for both changing market conditions and investor’s objectives
Exhibits 11.24, 11.25

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11.6.1 Integrated Asset Allocation (slide 2 of 3)

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Finding Expected Utility (Benefit/Satisfaction)
Exp. Utility (EU) = Exp Ret (ER) – Risk penalty
Or EU = ER – σ2/RT
σ2 = Risk or volatility; RT=Investor’s risk tolerance
Higher returns make investor happy (higher utility)
Higher risk makes those investors unhappy (low utility) who have low RT as they assign bigger penalty for taking more risk; high RT investors are not unhappy with high risk as they expect high return-high risk relation.
Portfolio with higher EU are better (maybe efficient portfolio).

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11.6.1 Integrated Asset Allocation (slide 3 of 3)

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11.6.2 Strategic Asset Allocation
Strategic asset allocation is used to determine the long-term policy asset weights in a portfolio
Typically, long-term average asset returns, risk, and covariances are used as estimates of future capital market results
Efficient frontiers are generated using this historical information, and the investor decides which asset mix is appropriate for his or her needs during the planning horizon
This results in a constant-mix asset allocation with periodic rebalancing to adjust the portfolio asset weights; no adjustment for changing market conditions and investor’s objectives.
Exhibit 11.26

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11.6.2 Strategic Asset Allocation (slide 2 of 2)

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11.6.3 Tactical Asset Allocation
Frequently adjusts the asset class mix in the portfolio to take advantage of changing market condition; adjust for changing market conditions only; no adjustment for investor’s objectives (assume constant).
Adjustments are driven solely by perceived changes in the relative values of the various asset classes; e.g., increase equity weight when stock market is rising.
Often based on the premise of mean reversion
An inherently contrarian method of investing

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11.6.4 Insured Asset Allocation
Results in frequent adjustments in the portfolio allocation, assuming that expected market returns and risks are constant over time, while the investor’s objectives and constraints change as his or her wealth position changes; adjust asset allocation for changing investor’s objectives only.
Involves only two assets, such as common stocks and T-bills
As stock prices rise, the asset allocation increases the stock component
As stock prices fall, the stock component of the mix falls while the T-bill component increases

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