Equity Portfolio Management
MIP, Chapter 7
Kevin C.H. Chiang
Approached to equity investment
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Passive management
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The dominant approach is indexing
Active management
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Seeks to outperform a given benchmark
By overweighting those stocks that deem
promising and underweighting those stocks that
deem less promising
Active return
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Active return: the differences between fund
returns and benchmark returns.
The goal of active management is try to
generate consistent positive active returns
(holding other factors constant, higher the
better).
Tracking ratio and information ratio
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Tracking risk: the standard deviation of active
returns (the lower the better).
Information ratio: the ratio of mean active
return to tracking risk (the higher the better).
Some sponsors impose expectations on
managers’ tracking risk and information ratio.
Popular equity indices
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Exhibit 7-10, pp. 420-421.
Investment style
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Investment style: a natural grouping of
investment disciplines that has some
predictive power in explaining the future
dispersion of portfolio/fund returns across
portfolios/funds.
Why one particular style? (1) Drives fund risk
and fund return, (2) allows research to be
more focused, (3) aligns with research
strengths and philosophy, (4) fund/plan
sponsors often requires style specialization.
Value style vs. growth style
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Value style: investing in high value/price (low
price/value) stocks; e.g., high B/M stocks, low P/E
stocks.
– A stylized value premium.
– At least 3 sub-styles: low P/E, contrarian, and
high yield.
Growth style: investing in low value/price (high
value/price) stocks.
– The most popular style among mutual funds.
– At least 2 sub-styles: consistent growth (a longhistory of sales growth, superior earnings), and
Big-cap style vs. small-cap style


Used to have a small-cap premium.
Small-cap style can impose liquidity/depth
risk on large funds.
Techniques for identifying styles

1st category: return-based methods, such as
regressions or Sharpe’s style analysis (a
special form of regression).
–
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An example of rolling style chart, Exhibit 7-13, p.
439)
2nd category: holdings-based analysis.
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Look into actual stock holdings.
Morningstar uses this method to construct its
3×3 style box for funds (Exhibit 7-18, p.448).
Style drift
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Drift: inconsistency in investment style over
time.
An obstacle to investment planning and risk
management from fund/plan sponsors’
perspectives.
Fund/plan sponsors usually monitor for signs
of style drift; managers may need to explain
for it.
SRI

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Socially responsible investing: one can
consider this to be a special style.
Some fund/plan sponsors today have an SRI
mandate.
Some fund/plan sponsors worry that an SRI
mandate will reduce diversification benefits.
Screening

Screening based on some criteria reflecting
investing style and philosophy, e.g., P/E,
earnings momentum, etc., is often used by
research units so that there is focus and
efficiency in research.
Structuring research
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Top-down: focus research on
macroeconomic/industrial factors or
investment themes.
The stock holdings in top-down investors’
portfolios reflect their macro insights.
Bottom-up: have little interest in the state of
the economy or other macro factors, but
rather try to put together the best portfolio of
stocks based on company-specific
information.
Sell-side vs. buy-side research

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Sell-side research is generally organized by
sector/industry with a regional delineation;
e.g., a U.S. banking analyst.
Buy-side research: mainly concerned with
assembling a portfolio, so decisions on buyside research are usually made through a
committee structure.
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These research reports/essays are not available
to outsiders.