19-EquityPort Page 591 Friday, March 12, 2004 12:40 PM
Equity Portfolio Management 591■ Practitioners view categories of stocks with similar historical perfor-
mance as a “style” of investing with the two main style categories
being growth and value.
■ There are methodologies for classifying stocks into style categories.
■ There are two types of passive strategies: a buy-and-hold strategy and
an indexing strategy with the latter being the more common strategy
pursued by institutional investors.
■ In constructing the tracking or indexed portfolio a manager can use the
capitalization approach which involves either purchasing all stock
issues included in the benchmark index in proportion to their weight-
ings or purchasing a number of the largest capitalized names in the
benchmark index and equally distributes the residual stock weighting
across the other issues in the benchmark index.
■ Two approaches to construct an indexed portfolio with fewer stock
issues than the benchmark index are the cellular (or stratified sampling)
method and the multifactor risk model method.
■ The “fundamental law of active management” explains how the infor-
mation ratio changes as a function of the depth of an active manager’s
skill and the breadth or number of independent insights or investment
opportunities.
■ Technical analysis strategies are active management strategies whose
overlying principle is to detect changes in the supply of and demand for
a stock and capitalize on the expected changes.
■ Technical analysis has taken a more scientific twist with the develop-
ment of nonlinear dynamics and chaos theory.
■ Market-neutral strategies seek a positive return regardless of market
conditions. A typical way to achieve this result is by constructing an
appropriate portfolio consisting of long and short equity positions.
■ Statistical arbitrage is a new methodology for managing long-short
equity portfolios based on finding stable trends that signal profit
opportunities.
■ Multifactor risk models permit the decomposition of risk in order to
assess the potential performance of a portfolio to the risk factors, the
potential performance of a portfolio relative to a benchmark, and the
actual performance of a portfolio relative to a benchmark
■ In risk decomposition, the total return is first divided into the risk-free
return and the total excess return (the difference between the actual
return realized by the portfolio and the risk-free return); the total
excess risk is further partitioned into specific/common risks, system-
atic/residual risks, and benchmark/active risks.