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CHAPTER 17 EQUITY PORTFOLIO MANAGEMENT STRATEGIES Answers to Questions 1. Passive portfolio management strategies have grown in popularity because investors are recognizing that the stock market is fairly efficient and that the costs of an actively managed portfolio are substantial. 2. Numerous studies have shown that the majority of portfolio managers have been unable to match the risk-return performance of stock or bond indexes. Following an indexing portfolio strategy, the portfolio manager builds a portfolio that matches the performance of an index, thereby reducing the costs of research and trading. In an indexing strategy, the portfolio manager’s evaluation is based upon how closely the portfolio tracks the index or “tracking error,” rather than a risk-return performance evaluation. 3. There are a number of active management strategies discussed in the chapter including sector rotation, the use of factor models, quantitative screens, and linear programming methods. Following a sector rotation strategy, the manager over-weights certain economic sectors, industries or other stock attributes in anticipation of an upcoming economic period or the recognition that the shares are undervalued. Using a factor model, portfolio managers examine the sensitivity of stocks to various economic variables. The managers then “tilt” the portfolios by trading those shares most sensitive to the analyst’s economic forecast. Through the use of computer databases and quantitative screens, portfolio managers are able to identify groups of stocks based upon a set of characteristics. Using linear programming techniques, portfolio managers are able to develop portfolios that maximize objectives while satisfying linear constraints. 4. Three basic techniques exist for constructing a passive portfolio: (1) full replication of an index, in which all securities in the index are purchased proportionally to their weight in the index; (2) sampling, in which a portfolio manager purchases only a sample of the stocks in the benchmark index; and (3) quadratic optimization or programming techniques, which utilize computer programs that analyze historical security information in order to develop a portfolio that minimizes tracking error. 17 - 1
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5. Managers attempt to add value to their portfolio by: (1) timing their investments in the various markets in light of market forecasts and estimated risk premiums; (2) shifting funds between various equity sectors, industries, or investment styles in order to catch the next “hot” concept; and (3) stockpicking of individual issues (buy low, sell high). 6. The job of an active portfolio manager is not easy. In order to succeed, the manager should maintain his/her investment philosophy, “don’t panic.” Since the transaction costs of an actively managed portfolio typically account for 1 to 2 percent of the portfolio assets, the portfolio must earn 1-2 percent above the passive benchmark just to keep even. Therefore, it is recommended that a portfolio manager attempt to minimize the amount of
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This note was uploaded on 05/20/2010 for the course FIN 5DLS taught by Professor Leejohn during the One '10 term at La Trobe University.

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