CFA III SS 11&12 Equity

• 1. weighted by price per share; a divisor adjustment removes the effect of dividends and splits; overrepresentation of firms with large share price
• 2. weighted by market cap; float adjusted, so computed on investable rather than outstanding shares; overrepresentation of large market cap firms
• 3. reflects average return of each stock; mainly used for academic purposes

• index - mutual fund or etf
• cash plus long equity futures
• cash plus total return equity

etfs generally lower cost (no individual shareholder recordsand have structural advantages, such as trade continuously, can be shorted, and shares are not redeemed for cash

• Pros: low transaction costs; very liquid
• Cons: short term contracts are the most liquid but must be rolled over

swap portfolio return for different, desired return; ex. rf of a market neutral with S&P 500

• 1. all stocks are purchased; pros - low tracking risk, less rebalancing cost (only when composition of index changes); cons - costly, and only plausible for small index (less than 1000 stocks)
• 2. match index on one or two dimensions; pros - low cost; cons - higher tracking risk
• 3. use factor model to match factor exposures of the index; pros - accounts for CoV b/w risk factors, lower tracking risk than stratified; cons - models are sensitive, freq rebalancing

• value
• growth
• market oriented

• returns based: regress manager returns with multiple known portfolios (large value, large growth, small value, small growth) and examine correlations and R2 over. Can be used over time to judge manager drift. 
• adv - quick and easy; easy to compare portfolios
• disadv - over time, so may not reflect current portfolio; inappropriate comp indices could lead to inaccurate results
• holdings-based style: examine and classify portfolio holdings, usually based on P/E level, EPS growth rate and variability, and industry sector
• adv - current, based on actual holdings
• disadv - subjective, data intensive, may not reflect how manager selects securities (ex. if they move from growth to value while held)

• screens securities based on social, ethical, or religious concerns; screens can be negative - won't purchase, or positive - seek certain stocks
• bias toward small cap growth

• long-only: can only purchase or not purchase stocks, so maximum underweighting is the index weight (ex. 0% in P vs 2% in index)
• long-short: buy undervalued and short overvalued stocks; can leverage portfolio by using short funds to purchase more long positions; can earn equitize by adding a long position in equity futures or ETFs

• manager matches long and short positions with similar stocks (usu same industry)
• market neutral strategy

• IR = IC * sqrt(IB)
• IR = information ratio
• IC = information coefficient; depth of knowledge
• IB = investor breadth; number of independent investment decisions (ex if buy all stocks in one sector as a single decision to buy sector, only counts as 1)

• both have market exposure plus alpha
• core-sat: majority of portfolio is indexed or semi-active, then choose satellite managers to vary with certain funds, adding alpha and tracking risk
• completeness: start with value add managers then add market portfolio; market portfolio considers value add managers holdings

• some funds invested in index
• some funds invested in long-short market neutral
• this separates alpha and beta
• creates portable alpha bc its not related to market portfolio

value add = active return / active risk

• true value add = true act return / true act risk
• true act return = manager's return - manager's normal benchmark
• total act risk = sqrt(true act risk^2 + misfit act risk^2); solve this eq to get true act risk

• total act return = manager's return - investor's benchmark
• misfit return = manager's normal benchmark - investor's benchmark

• mostly applies to international indices
• breadth is the number of securities covered by index
• investability is the liquidity of the securities in the index
• these are inversely related

• stocks added to index increase in price, and removed stocks decrease in price, so adding/removing from an indexed portfolio is disadvantageous (buy high, sell low)
• effect is more prominent in judgmental indices (vs objective and transparent) bc investors don't know when a stock will be added or removed

• 1. only social responsibility of business is to increase profits
• 2. morality is determined by consequences - cost/benefit analysis; leads to seeking greatest good for greatest number of people; hard to calculate and may lead to exploiting small groups
• 3. people should be treated with dignity and respect, they are not machines; incomplete philosophy bc does not address sympathy or caring
• 4. fundamental rights trump collective good; managers must have a moral compass
• 5. fair and equitable distribution of goods and services is just; argues rules are fair if all would agree to distribution under "veil of ignorance," meaning don't know which one they will receive.