CHAPTER NINE: INVESTMENT PORTFOLIO MANAGEMENT

An investor is a party that makes an investment into one or more categories of assets --- equity, debt securities, real estate, currency, commodity, derivatives such as put and call options, etc. --- with the objective of making a profit.  Inviduals  Organizations: Financial entities including Brokerages, Banks, Funds…
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CHAPTER NINE: INVESTMENT PORTFOLIO MANAGEMENT CHAPTER NINE: INVESTMENT PORTFOLIO MANAGEMENT06/08/2011 1 INVESTOR An investor is a party that makes an investment into one or more categories of assets --- equity, debt securities, real estate, currency, commodity, derivatives such as put and call options, etc. --- with the objective of making a profit.  Inviduals  Organizations: Financial entities including Brokerages, Banks, Funds…06/08/2011 2 INVESTMENT PROCESS - Analyze the market - Evaluate expected returns and risks - Design the optimized portfolio06/08/2011 3 Risk aversion U =E(r) -0,5A. Б2 Б2 = 0 -> U = E(r) (Risk free portfolio) Risk of portfolio and Diversification Return and Risk of portfolio: [8-9] n ER p   ( wi  ERi ) i 106/08/2011 4 PORTFOLIO MANAGEMENT Active Management – The process of managing investment portfolios by attempting to time the market and/or select “undervalued” stocks to buy and “overvalued” stocks to sell based upon company research, investigation and analysis Passive Management – The process of managing investment portfolios by trying to match the performance of an index or asset class of securities as closely as possible by holding all or a representative sample of the securities in the index or asset class – Does not use market timing or stock selection strategies06/08/2011 5 Investment Decision Matrix: Where Do You Fit In? Market Timers and Stock Selectors* 1. 2. Stock Selectors Where the common crowd hangs out Preference of stockbrokers and many financial Preference of active management, advisors* high-cost “gurus*” High cost, high turnover, high taxes Heavy on investment hype The Informed Investor 3. 4. Market Timers Based on academic research and data* Tactical analysis* (with no proven results) As much as 40% of institutional invested dollars Tax inefficient The prudent investors Short-term outlook Receive market returns Where YOU should be (and where we are)06/08/2011 6• Asset Class Investing – Stocks and Bonds – US and International – Large Cap and Small Cap – Growth and Value – Short-Term and Long-Term Maturity06/08/2011 7• Why Use Passive Asset Class Investing? – Lower portfolio turnover – Lower operating expenses – Lower transaction costs – Greater tax-efficiency – Long-term perspective – Broad diversification/risk reduction – Control of asset allocation – Passive asset class funds capture separate dimensions of worldwide returns06/08/2011 8 Passive versus Active Portfolio Management• Review of Market Efficiency• Anomalies• Market Timing• A theoretical model of active portfolio management (Treynor-Black)• Quantitative Investment Management06/08/2011 9 Passive Management• Buy and Hold• Indexation• Active management must beat these strategies on a net risk adjusted return basis!• What if markets are efficient?06/08/2011 10 Treynor-Black Model• Suppose you can identify securities that you expect to outperform (or underperform) on a risk-adjusted basis• How do you exploit this model?06/08/2011 11 Treynor-Black Model: Assumptions• Analysts can only produce quality ana ...