Chapter 16

Equity Portfolio
Management
Strategies
OUR TEAM

Trần Minh Tuyết Mai Phạm Công Hoàng Lâm Nhựt Phi
31201022425 31201020324 31201020772

Phạm Nguyễn Nguyễn Ngọc Minh

Nguyễn Thu Trang
Phương Anh Thư
31201021615 31201022820 31201022790
 CONTENTS

01
Passive Versus 02
Active Management An Overview Of Passive
Equity Portfolio
Management Strategies
03
An Overview Of Active
Equity Portfolio
Management Strategies
 CONTENTS

04 Value Versus Growth Investing: A Closer Look

0
Tax Efficiency and Active Equity Management

0
An Overview Of Style Analysis

Asset Allocation Strategies

01
PASSIVE VERSUS ACTIVE MANAGEMENT
1. Passive Versus Active Management

Total Actual Return = [Expected Return] + [“Alpha”]

= [Risk-Free Rate + Risk Premium] + [“Alpha”]

= Passive + [“Alpha”]

Active
1. Passive Versus Active Management - Definitions

Passive Active
Mimic a particular index to achieve Outperform an equity benchmark on
similar results. a risk-adjusted basis.

Minimize the deviation between Add alpha: tactical adjustments or

stock portfolio and index returns. security selection skills.

Doesn’t require daily attention but

the portfolio need to rebalance Need constant attention.
occasionally
 QUESTION
What are advantages and disadvantages
between active management and passive
management?
02 AN OVERVIEW OF PASSIVE
EQUITY PORTFOLIO
MANAGEMENT STRATEGIES
 2. An Overview Of Passive Equity Portfolio
Management Strategies
2.1. Overview

PASSIVE MANAGEMENT
A long-term buy-and-hold strategy
replicates the performance of a
specific benchmark to match the
market performance.
 2. An Overview Of Passive Equity Portfolio
Management Strategies
2.1. Overview
Attempting to replicate the
performance of an index

PASSIVE MANAGEMENT Advocating the random walk

theory
Costing often cheaper
Having strong rationale

Many different market indexes can be used: Russell 2000, Russell Growth Index,
EAFE Index, etc.
2. An Overview Of Passive Equity Portfolio Management
Strategies

Question
Why have passive portfolio
management strategies increased in
use over time?
2. An Overview Of Passive Equity Portfolio Management
Strategies
Question
Why have passive portfolio management
strategies increased in use over time?

Answer
Passive portfolio management strategies have grown
in popularity because investors are recognizing that
the stock market is fairly efficient and that the costs
of an actively managed portfolio are substantial.
 2. An Overview Of Passive Equity Portfolio
Management Strategies
2.2. Index portfolio construction techniques

Advantage:
Ensuring close tracking
FULL REPLICATION
All securities in the index are
purchased in proportion to
weights in the index
Drawback:
Increasing transaction costs
 2. An Overview Of Passive Equity Portfolio
Management Strategies
2.2. Index portfolio construction techniques

Advantages:
● Fewer stocks mean lower costs
● Reinvestment of dividends is
SAMPLING less difficult
Buying a representative
sample of stocks in the
benchmark index according
to their weights in the index Drawback:
There will be some tracking errors
 2. An Overview Of Passive Equity Portfolio
Management Strategies
2.2. Index portfolio construction techniques

Advantages:
● Minimizing tracking error
QUADRATIC with the benchmark.
OPTIMIZATION/PROGRAMMING ● Fewer stocks
Historical data on price changes
and correlations between securities
are input into a computer program Drawback:
that determines the composition of Relying on historical
a portfolio. correlations, leading to failure
to track the index
 2. An Overview Of Passive Equity Portfolio
Management Strategies
2.3. Tracking Error & Index Portfolio Construction

Tracking Error (TE)

measured as the standard
deviation of return differential
in time period t (∆t)
 2. An Overview Of Passive Equity Portfolio
Management Strategies
2.3. Tracking Error & Index Portfolio Construction
 2. An Overview Of Passive Equity Portfolio
Management Strategies
2.3. Tracking Error & Index Portfolio Construction
 2. An Overview Of Passive Equity Portfolio
Management Strategies
2.3. Tracking Error & Index Portfolio Construction
 2. An Overview Of Passive Equity Portfolio
Management Strategies
2.3. Tracking Error & Index Portfolio Construction

What is the annualized tracking error (TE) for this two-year period?
 2. An Overview Of Passive Equity Portfolio
Management Strategies
2.3. Tracking Error & Index Portfolio Construction
2. An Overview Of Passive Equity Portfolio
Management Strategies
 2. An Overview Of Passive Equity Portfolio
Management Strategies
2.3. Tracking Error & Index Portfolio Construction

Alford, Jones, and Winkelmann (2003) have also shown that tracking
error can be a useful way to categorize a fund’s investment style.
 2. An Overview Of Passive Equity Portfolio
Management Strategies
2.4. Methods of Index Portfolio Investing

2.4.1. Index Funds

In an indexed portfolio, the

fund manager will typically attempt
to replicate the composition of the
particular index exactly (buy the
exact securities comprising the index
in their exact weights)
 2. An Overview Of Passive Equity Portfolio
Management Strategies
2.4. Methods of Index Portfolio Investing

2.4.1. Index Funds

Change those positions anytime the composition

of the index itself is changed
Low trading and management expense ratios
Provide an inexpensive way for investors to
acquire a diversified portfolio
 2. An Overview Of Passive Equity Portfolio
Management Strategies
2.4. Methods of Index Portfolio Investing

2.4.2. Exchange-Traded Funds (ETF)

Depository receipts that give

investors a pro-rata claim on the capital
gains & cash flows of the securities that
are held in deposit by a financial
institution that issued the certificates.
 2. An Overview Of Passive Equity Portfolio
Management Strategies
2.4. Methods of Index Portfolio Investing

2.4.2. Exchange-Traded Funds (ETF)

Can be bought and sold (and short

sold) like common stock.
Example: Standard & Poor’s 500
Depository Receipts (SPDRs), iShares, &
Sector ETFs.
2. An Overview Of Passive Equity Portfolio
Management Strategies
Top 7 prestigious ETFs in Vietnam (Synthesis by topi.vn)
2. An Overview Of Passive Equity Portfolio Management
Strategies

Question
What is the main difference between Index
funds & ETFs?
 3. An Overview Of Active Equity Portfolio
Management Strategies

Fundamental Technical Anomalies

 3. An Overview Of Active Equity Portfolio
Management Strategies

Shifting funds among asset classes

Shifting funds among equity sectors/industries,

3.1 investment styles
Fundamental
Looking at individual issues to find undervalued
stocks
 3. An Overview Of Active Equity Portfolio
Management Strategies

Buy the assets that are currently out of favour and sell the
asset class with the highest market value.

Tactical Based on the premise of mean reversion

Asset
Allocation Factors affected in the rebalancing:
- General level of volatility in the capital market
- Relative equity and fixed-income risk premiums
- Changes in the macroeconomic environment
 3. An Overview Of Active Equity Portfolio
Management Strategies

As the economy moves forward, different sectors of the

economy tend to perform better than others.
Sector
Rotation
Strategy Overweighting certain economic sectors or industries
in response to the next expected phase of the business
cycle.
 QUESTION

Because of inflationary expectations, you expect natural

resource stocks, such as mining companies and oil firms
to perform well over the next three to six months.

As an active portfolio manager, what are your methods to

take full advantage of this?
 ANSWER

Emphasize or overweight, relative to the benchmark,

investments in natural resource stocks.

The portfolio manager could also purchase options on

natural resource stocks.
3. An Overview Of Active Equity Portfolio
Management Strategies
130/30 Strategy
Long positions up to 130 per cent and have short positions up to
30 per cent

Short positions creates the leverage needed to extend the long

positions

Expand the ways in which investors can capture available alpha

3. An Overview Of Active Equity Portfolio
Management Strategies
Earning Momentum Strategy

Company’s share price will follow the direction of its earnings, which
is one measure of the firm’s economic success.

Purchases and holds stocks that have accelerating earnings and sells
(or short sells) stocks with disappointing earnings.
3. An Overview Of Active Equity Portfolio
Management Strategies

Contrarian Investment Strategy

3.2
Technical Price Momentum Strategy
3. An Overview Of Active Equity Portfolio
Management Strategies
Contrarian Investment Strategy

Buy (sell) a stock is when the majority of other investors are the most
bearish (bullish) about it.

Based on the premise of mean reversion

Tactical Asset Allocation adopted this approach.

3. An Overview Of Active Equity Portfolio
Management Strategies
Price Momentum Strategy

Focuses on the trend of past prices

Stocks with consistently strong, positive returns regardless of

why they occurred.
Comparison between Earning Momentum
Strategy and Price Momentum Strategy
Comparison between Earning Momentum
Strategy and Price Momentum Strategy
Comparison between Earning Momentum
Strategy and Price Momentum Strategy

Earning Momentum Strategy Price Momentum Strategy

 QUESTION
Under what conditions would you expect
the two approaches to produce similar
portfolios?
 ANSWER
When the stocks that have shown strong price
movements in the recent past also have strong
earnings growth in the recent past.
 3. An Overview Of Active Equity Portfolio
Management Strategies

Anomalies (January Effect, Weekend

Effect,… )
3.3 Anomalies
Attributes (Firm size, financial ratio,… )
 3. An Overview Of Active Equity Portfolio
Management Strategies

Anomalies Attributes

January Effect Firm size

Stock prices regularly tend to fall in the Firms with smaller market
last month and rise in the first month of capitalizations produce bigger risk-
the year adjusted returns.

Weekend Effect Financial Ratio

Stock prices regularly tend to fall on Firms with lower P/E and P/BV ratios
Monday and rise on Friday produce30%
bigger risk-adjusted returns.
04
VALUE VERSUS GROWTH INVESTING:
A CLOSER LOOK
4. VALUE VERSUS GROWTH INVESTING: A CLOSER LOOK

Growth Investment Value Investment

Focus on the EPS component and its Focus on the price component,
economic determinants attracted by “cheap” stock

Companies that exhibit rapid EPS Not care about current earnings or the
growth in the future
fundamental drivers of earnings growth

P/E ratio will remain constant over the

P/E ratio is below its natural level
near term
05
Tax Efficiency and
Active Equity Management
 5. Tax Efficiency and Active Equity Management
Active Equity Management

Two potential costs

Form a portfolio that usually requires Transaction Costs Tax Consequences

trading stocks into and out of the fund
frequently.

Every dollar of these costs is a dollar less of

potential return.
5. Tax Efficiency and Active Equity Management
a. Transaction Costs

All investors have to bear these costs.

There is a powerful relationship between

low costs and relatively higher returns.

Calculation formula:

→ Low-cost fund outperformed the high-cost fund.

5. Tax Efficiency and Active Equity Management
b. Tax Consequences

Who? When?

Only investors, who hold their portfolio in a Pay tax on capital gains from selling
taxable account, need to worry about the tax stocks that have appreciated in price
efficiency.
Reichenstein (2006); Horan & Adler (2009)

Tax-Deferred Investors:

● Institutional funds
● Individuals who have retirement plans
5. Tax Efficiency and Active Equity Management
b. Indirect Measure: Portfolio Turnover
Example

It is a good indicator of overall trading activity. An active manager that sold $75 million
worth of stocks in a year from a portfolio
that averaged $100 million in assets
Many of those trades might have been
transacted at losses that actually offset the gains → Turnover ratio= 75%.
created by other sales.
→ The manager has replaced three out of
every four stocks in the portfolio at some
Calculation formula:
point during the year.
5. Tax Efficiency and Active Equity Management
b. Direct Measure: Tax Cost Ratio

shows how well do portfolio managers balance the capital gains and losses

represents the percentage of an investor's assets that are lost to taxes on a yearly
basis. Ptak (2002)

Assuming that investors pay taxes on net short-term and long-term capital gains at the
highest rate, calculation formula:

The Higher the Tax Cost Ratio, The More Tax-Inefficient Active Managed Portfolio
5. Tax Efficiency and Active Equity Management
5. Tax Efficiency and Active Equity Management

QUESTION
Is “Minimizing tax cost” a good objective
while managing active equity portfolio?
06
AN OVERVIEW OF STYLE
ANALYSIS
 6. An Overview Of Style Analysis

Attempts to explain the

variability in the observed
returns to a security
STYLE ANALYSIS portfolio
The goal is properly classify
the manager’s strategy
6. An Overview Of Style Analysis
6. An Overview Of Style Analysis

Sharpe’s return-based style analysis multifactor models:

: the tth period return to the portfolio of Manager p

: the tth period return to the jth style factor

: the sensitivity of Portfolio p to Style j

: the portion of the return variability in Portfolio p not explained by

variability in  the set of factors
 6. An Overview Of Style Analysis

The coefficient of determination:

the percentage of Manager p’s return variability

due to the portfolio’s style

(1 − ) due to his or her selection skills.

Exhibit 16.22 Style Analysis for Two Mutual Funds
Exhibit 16.23 Mutual Fund Styles over Time
07
Asset Allocation Strategies
 7. Asset Allocation Strategies

Integrated asset allocation

Capital market conditions

Strategic asset allocation

Assumptions
Tactical asset allocation

Investor’s objectives and

constraints
Insured asset allocation
 7. Asset Allocation Strategies

Integrated asset allocation ● Involving the consideration of both the economic

expectations and risk factors in deciding the asset
mix.
Strategic asset allocation

Tactical asset allocation

Insured asset allocation

 7. Asset Allocation Strategies

Step 1

Step 3 Step 2

Sharpe (1987, 1990)

7. Asset Allocation Strategies
Step 2

Where:
ERp: the expected return (C3)

σ2p: variance for Portfolio p (C3)

RTk: risk-tolerance factor for Investor k (I3)

 7. Asset Allocation Strategies
Dynamic process

Step 1

Step 3 Step 2

Sharpe (1987, 1990)

 7. Asset Allocation Strategies

Integrated asset allocation

● Being used to determine the long-term policy asset weights

Strategic asset allocation
● Promoting investment diversification to minimize risks and
maximize returns
Tactical asset allocation

Insured asset allocation

7. Asset Allocation Strategies
 7. Asset Allocation Strategies

Integrated asset allocation

Strategic asset allocation

● A moderately active strategy with desired short-term profits

Tactical asset allocation
● Mean reversion

● Contrarian method

Insured asset allocation

7. Asset Allocation Strategies
 7. Asset Allocation Strategies

Integrated asset allocation

Strategic asset allocation

Tactical asset allocation

● Avoid risk entirely

Insured asset allocation
● A constant proportion strategy
7. Asset Allocation Strategies
7. Asset Allocation Strategies

Question 1
Tactical asset allocation is best described as:

A. Attempts to exploit arbitrage possibilities

among asset classes.
B. The decision to deliberately deviate from the
policy portfolio.
C. Selecting asset classes with the desired
exposures to sources of systematic risk in an
investment portfolio.
7. Asset Allocation Strategies

Question 1
Tactical asset allocation is best described as:

A. Attempts to exploit arbitrage possibilities

among asset classes.
B. The decision to deliberately deviate from the
policy portfolio.
C. Selecting asset classes with the desired
exposures to sources of systematic risk in an
investment portfolio.

Answer: B
7. Asset Allocation Strategies

Question 2
What is the main difference between the
integrated, strategic, tactical, and insured
approaches to asset allocation?
 7. Asset Allocation Strategies

Integrated asset allocation

Which asset allocation strategy should be used by the manager?

Strategic asset allocation

The client’s objectives and constraints

Tactical asset allocation

The relationship between past and future capital market

Insured asset allocation
conditions
 7. Asset Allocation Strategies

CONSTANT
Integrated asset allocation

Strategic asset allocation

Capital market conditions

Tactical asset allocation

Insured asset allocation Investor’s objectives and

constraints
 7. Asset Allocation Strategies

CONSTANT
Integrated asset allocation

Strategic asset allocation Investor’s objectives and

constraints

Tactical asset allocation

Insured asset allocation Capital market conditions

 7. Asset Allocation Strategies

Integrated asset allocation

Capital market conditions

Strategic asset allocation

NOT
CONSTANT
Tactical asset allocation

Investor’s objectives and

constraints
Insured asset allocation
 7. Asset Allocation Strategies

Integrated asset allocation

Capital market conditions

Strategic asset allocation

CONSTANT
Tactical asset allocation

Investor’s objectives and

constraints
Insured asset allocation
Thank you for your listening
Any questions?