Client screening options (4) (PINT)
1. positive screening: rank favorably for client2. impact investing: active engagement in company matters3. negative screening: exclude per client4. thematic investing: based on theme (e.g., climate change)
Primary investment segmentation (3) (SEG) and benefits
1. size / style: large vs. small / growth vs. value2. economic activity: market orientated (markets served, customer product use, cash flow generation, e.g. GICS) and production orientated (products made, inputs required, e.g. ICB)3. geography: developed, emerging, frontierBenefits: specific sector benchmarks and diversification
Security lending issues (4) (VCDP)
1. voting right loss2. credit quality of borrower3. dividend payments out4. price driven down (bad if currently holding)
Active management risk (3) (PRK)
1. portfolio turnover is higher2. reputation risk3. key person risk
Equity index requirements (3) (RIT)
1. rules-based: inclusion/exclusion, weighting, rebalancing2. investable: replicate return and risk3. transparent: public, clearly stated
Index weighting approaches (4) (FEPM)
1. fundamental weighting: by fundamental factor (e.g., sales, income, dividend)2. equal-weighting: by equal amounts in each3. price-weighting: by price4. market-cap weighting: by market cap as a percentage to all stocks in index
Herfindal-Hirschman Index
Sum of squared weights of individual stock in portfolioEffective number of stocks = 1 / HHI
Reconstitution and trading cost reduction (2)
Reconstitution: removing or replacing stocks from indexTrading cost reduction:1. buffering: threshold level must be above zone 2. packeting: 1/2 of position moved initially, if meets again, next 1/2 is moved
Fama and French Factors (5) (MFBOI)
1. market risk: beta2. firm size: market value of equity3. book-to-market value (shareholders / market cap)4. operating profitability (operating income / BOP shareholder's equity)5. investment intensity (growth rate of total assets)
Common approaches to passive equity investing (2)
1. pooled investments: open-end mutual funds / ETFs2. derivatives based strategies: Advantages: can be used to quickly adjust portfolio factors at low cost, trade in liquid markets. Disadvantages: finite expirations, position limits, country party risk, tracking error
Causes of tracking error (5) (MSICC)
1. management fees2. sampling3. intraday trading (indexes based on closing prices)4. commissions5. cash drag
Value-based approaches (7) (RICHS)
1. relative value: multiple comparison2. income investing: dividends3. contrarian investing: against market sentiment4. high-quality value: equal emphasis on intrinsic value and financials (i.e., Warren Buffett)5. special situations: corporate events (e.g., divestitures, M&A)Other6. restructuring / distressed: prior or during bankruptcy7. deep-value: extremely low valuations
Hedged portfolio approach process (4) (RDLT) and drawbacks (3) (MAN)
Process1. rank by factor2. divide by quantiles3. long best and short worst quantiles4. track performance over timeDrawbacks1. middle quantile information lost2. appearance of more diversification3. not "pure" factorOther Drawbacks4. assumption of short capability5. assumption that linear relationship exists between factor and stock return
Activist investor tactics (5) (BOARD)
1. BOD representation2. open letters3. annual meeting proposals4. reducing excessive management comp5. dividend / buyback pushOther6. breaking up conglomerate7. legal proceedings for breach of fiduciary duty8. media campaign
Activist defense strategy (3) (PMS)
1. poison pill: purchase shares at discount2. multi-class share structures: more votes to founders3. staggered board: partial reelections
Other Equity strategies (3) (PRS)
1. pairs trading: two highly correlated positions breakdown2. risk (merger) arbitrage: buy target of M&A sell acquirer3. statistical arbitrage: exploit stock price and volume data, often mean reversion related
Fundamental active investment strategy (7 steps) (DPAFCCR)
1. define investment universe2. prescreen investment universe3. analyze industry, competitive position, financial reports4. forecast performance5. convert forecast to valuations6. construct portfolio with desired risk profile7. rebalance as needed
Quantitative investment process (5 steps) (DABEC)
1. define market opportunity2. acquire and process data3. back-test strategy4. evaluate5. construct portfolio
Pitfalls in quantitative investing (5) (TOLLS)
1. transaction costs2. overcrowding (bad if everyone leaves at same time)3. look-ahead bias (financial reporting and market move mismatches)4. lack of availability of stock to borrow5. survivorship biasOther6. turnover 7. data-mining/overfitting
Building blocks of portfolio construction (4) (FAPB)
1. factor weighting 2. alpha skill3. position sizing4. breadth of expertise
fundamental law of active management
Large number of independent bets (higher breadth) should lead to higher active returnE(R_A) = expected active return of portfolioIC = expected information coefficient of manager, calculated as correlation between manager forecasts and realized active returnsBR = breadth (number of truly independent decisions made per year)TC = transfer coefficient (number between 0 - 1 that measures level which manager is constrained. 1 is no constraints and 0 if fully constrained)omegaR-A = active risk (volatility of active returns)
active share
-Degree to which number and sizing of positions are different from benchmark-vale between 0 - 1, holding entire benchmark equals 0
active risk (tracking error) and composition (4) (HANA)
Standard deviation of active return (portfolio returns minus benchmark returns)Composition1. high exposure to risk factor = active risk up2. active risk attributable to active share is inversely proportional to number of securities in portfolio3. no factor exposure = active risk = active share4. active risk increases as factor and idiosyncratic risk increases
Active Risk and Active Share examples (5) (PFFFS)
1. pure indexing (equal to benchmark): zero active share and risk2. factor neutral: (no factor bets): low active risk, active share low is diversified3. factor diversified (balanced factor exposure, high number of securities): low active risk, high active share from non-benchmark securities4. factor bets (targeted factor bets): high active share and risk5. stock picker (targeted stock bets): highest active share and risk
Absolute risk
measures size and composition of absolute portfolio risk without reference to benchmark
contribution of asset to portfolio variance
0
Risk constraints (2)
1. heuristic: based on experience or good practice (e.g., individual limit exposure, sector or region, leverage limits, etc.)2. formal risk constraints: CVar, Marginal VaR, etc.
Slippage costs (4) (GUNS)
Slippage: difference between execution price and midpoint of quoted bid/ask when trade was entered1. greater for small cap2. usually higher than explicit costs3. not necessarily greater in emerging markets4. substantially higher in times of market volatility
well constructed portfolio (4) (CORD)
1. clear investment philosophy and process2. operating costs are reasonably low3. risk and structural characteristics as promised4. desired risk exposures in efficient manner
Benefits (4) (NLMR) and drawbacks (4) (FUCS) of long / short strategies
Benefits1. negative ideas are easier to express2. leverage3. market risk can be removed4. risk factor exposure control Drawbacks1. forced liquidation2. unlimited losses3. can require leverage (thus more risk)4. security borrowing costs