Equity Portfolio Management

About Equity:

1. US Equity ~ half of the world equity
2. US institutional investors have ~ 60% equity
3. Europe ~20% in portfolio
4. Equity can be a good hedge to inflation if inflation is taken into account and the company is in less competitive environment

Passive equity management: e.g. indexing (still need management to track index)

Active equity management: try to outperform the benchmark

Semiactive management: enhanced indexing/ risk-controlled active management

Tracking risk is just tracking error.

AR(active)>AR(semi)>AR(passive)

TR(active)>TR(semi)>TR(passive)

IR(semi)>IR(active)>IR(passive)

Active management on average does not outperform passive investment, because of cost.

If market is efficient, passive management is preferred, especially if investor is taxable.

Small cap may be less efficient, but turnover cost is also higher!

Foreign market is less transparent, passive manage may be better (unless you can get the material information earlier than others)

Indices:

1. Price weight (DJIA, Nikkei)
1. Bias towards large cap
2. One share per stock: not realistic
2. Value weight (market-cap weight)
1. Bias towards large cap
2. May not able to mimic if subject to max holdings
3. Free Float-adjusted market cap weight (only take free float shares into account) (S&P, Russell)
4. Equal-weight: same dollar amount in each share (Value Line Composite Average)
1. Bias towards small caps
2. Rebalancing is expensive

Index reconstitution: adding or deleting stocks

Compared to index mutual fund, Exchanged-Traded Fund (ETF): trade throughout the day, need brokerage fee, don’t need record keeping of share holders, more tax efficient, pay more license fee to S&P.

Pooled Accounts: index institutional accounts managed by one manager

May have lower management fee. Lending securities can help to offset expenses also.

Equity Future = Equity Index Future

Equity Total Return Swap: exchange equity return for equity index return