Concepts Description
Introduction to Equity Portfolio Management
Roles of equities in portfolio 1. Capital appreciation : from investing in companies experiencing growth in CF, revenue, earnings
‐ outperform other asset classes during strong economic growth
‐ underperform other asset classes during weak economic growth
2. Dividend income : 1%‐3% annually
‐ not guarantee to increase / continue in the future
‐ more stable than capital appreciation
3. Diversification : due to less than perfect correlation with other asset classes
‐ Economic crisis could decrease the risk reduction ability, due to :
+ correlation tend to increase toward 1.0 during crisis
+ volatility of assets is likely to increase
4. Inflation hedge : when company could charge customers more when input costs increase
‐ Related issues :
+ equities and inflation become negatively correlated during hyperinflation
+ equity prices are leading indicator, while inflation is lagging indicator
Client investment considerations Decision to include equities / types of equities : depend on client investment considerations, stated in Investment Poliy Statement (IPS)
High risk tolerance : growth‐oriented companies
Low risk tolerance : stable, well‐established companies
Client constrants : include Environment, Social and Governance (ESG) consideration and religious beliefs. Constraints could be addressed by :
‐ Negative screening : exclude companies / sectors do not meet requirements
‐ Positive screening : find companies / sectors that is most favorable by clients
‐ Thematic investing : screen equities based in specific theme
Equities segmentation 1. Size & Style :
‐ Size (measured by market cap) : large‐cap / mid‐cap / small‐cap companies
‐ Style (determined by company metrics ‐ PE ratio, PB ratio, dividend yield) : growth / blend / value companiesfits
‐ Advantages :
+ Better address client investment considerations in term of risk / return
+ Diversification benefits by investing across different sectors / industries
+ Able to construct relevant benchmarks for funds that invest in specific size/style category
+ Able to analyse changes in company characteristics over time
‐ Disadvantages :
+ Categories not stable over time
2. Geography : categorise international markets by stage of economic development (developed markets, emerging markets, frontier markets)
‐ Advantage : diversification across international markets
‐ Disadvantage :
+ subject to currency risk
+ overestimation of diversification benefit
3. Economic activity : group companies into sectors using market‐oriented / production‐oriented approach
‐ Market‐oriented : combine by markets served + how products are used by customers + how CF are generated (i.e.: Global Industry Classification Standards ‐ GICS)
‐ Product‐oriented : combine by products manufactured + required input in production process (i.e.: Industrial Classification Benchmark ‐ ICB ; Thomson Reuters Business
Classfication ‐ TRBC ; Russell Global Sectors Classification ‐ RGS)
‐ Advantage :
+ able to construct / analyse / compare performance benchmark based on specific sectors
+ diversification across different sectors
‐ Disadvantage : large companies may operate in multiple sectors
Types of portfolio income 1. Dividend income : subject to income / withholding tax ; less important to growth‐oriented portfolio
‐ Option stock dividend : allow investor to choose between cash payments and stock dividends. The option could be sold to other investors for money
‐ Special dividend
2. Security lending : lend security for a fee (0.2%‐0.5% in developed markets) and collateral / cash (which could generate return to lender via reinvestment). Borrower compensate
lender for any dividend payments during the loan period.
‐ Issues with security lending :
+ Lend security for short selling → ↓ stock price → ac ve manager's concern
+ Quality of borrower + Borrower's ability to return the securities
+ Loss the right to vote during loan period
‐ Issues with collateral reinvestment :
+ Subject to risks (market / credit / operational risk)
+ Additional costs (admin cost) to keep track
3. Writing option : to earn option premiums. E.g.:
‐ Covered call : sell call option on owned stock → lose upside poten al if price increases above strike price
‐ Cash‐covered put : sell put option on stock + prepare cash to pay for the stock if buyer exercises their right
4. Dividend capture : buy stock before ex‐dividend date + sell stock after ex‐dividend date. Only profitable if ↓ stock price < dividend
, Types of portfolio costs and fees 1. Management fees :
‐ to compensate for manager, pay research & analysis, computer hardware & software, compliance, processing trade
‐ based on % of assets under management
‐ due at regular time intervals
‐ vary : higher for actively management portfolio, lower for passively management portfolio
2. Performance (Incentive) fees : when portfolio outperforms a stated benchmark
‐ High‐water mark : protect investor from paying for performance twice
3. Administration fees : to pay for corporate activities
‐ Custody fees : charged when a custodian hold assets independent of portfolio manager
‐ Depository fees : charged for :
+ assist custodians with segregating portfolio assets
+ verify portfolio complance with investment limits (e.g.: leverage, cash requirements)
4. Marketing and Distribution fees : to cover :
‐ Marketing, sales and client services teams
‐ Advertise investment products / services
‐ Sponsor / Present at conferences
‐ Develop / Distribute marketing materials
‐ Fees from online platforms that offer multiple fund options
‐ Sales commissions for financial intermediary service (financial planners, brokers)
5. Trading costs : costs from buying / selling securities
‐ Explicit costs : include broker commissions, stock exchange fees, taxes
‐ Implicit costs : include bid‐ask spread, price impact from the transaction, delay costs (from not completing an entire trade due to illiquidity)
6. Investment strategy costs : cost related to chosen investment strategy
‐ Costs from Predatory trading : costs from rebalancing passive fund
Shareholder engagement 1. Definition : investors work with managers to have favorable impact on stock price via voting on corporate issues at general meetings. Main issues are :
‐ Corporate strategy : objectives, constraints, growth opportunities, resources
‐ Capital allocation : select new project, strategy for M&A, CAPEX, leverage, dividend payment and equity financing
‐ Corporate governance
‐ Compensation structure : top management remuneration, alignment with shareholder interest
‐ Composition of BOD : experience, competence, diversity, culture, effectiveness
2. Impact of shareholder engagement :
‐ Other investors not involving in the shareholder engagement also benefit from the increase in stock price, without time and cost fo the engagement
‐ Other stakeholders (e.g.: employees, customers, creditors, regulators, governments) are also affected by outcomes of shareholder engagement
3. Limitations of shareholder engagement :
‐ Costly + time‐consuming
+ Suit for active managers (influence companies in expected way to improve performance)
+ Not suit for passive managers (minimise costs)
+ Easily absorbed by large investors, over a large amount of assets
‐ May focus on ST goal (increase CF / stock price at the expense of LT goal)
‐ Risk of insider trading, due to acquisition of material non‐public information
‐ Create potential conflict of interest
4. Shareholder engagement for activist investing : Activist investors may :
‐ Propose shareholder resolutions + launch media campaign to influence vote
‐ Seek representation in BOD
‐ Launch proxy fight to achieve goal
Reasons for choosing active / 1. Confidence in manager's expert knowledge and skill
passive investment 2. Client preferences :
‐ Growth strategy → ac ve investment
‐ Value strategy → passive investment
3. Client constraints → require more ac ve approach (use screening / other techniques to meet the constraints)
4. Costs and fees : Active investment have higher cost
5. Certainty of result : Active investment's results are less certain
6. Narrowly defined benchmark → no opportuni es for ac ve managers to add value
Strategies to manage client 1. Manage a reasonable investor's expectations from the strategy. Unreasonable expectation → dissa sfac on
preferences 2. Too popular strategy → too much capital inflow → hard to find opportuni es to add value
3. Select appropriate benchmark : benchmark that contain a broad range of underlying equities with sufficient liquidity to support active management
Risks of active management 1. More costly
2. Less certain result
3. Reputation risk : from violations to ruls, regulations, client agreement and moral principles
4. Key person risk : loss of individuals who are essential to the success of the fund
5. High portfolio turnover → higher tax burden
Introduction to Equity Portfolio Management
Roles of equities in portfolio 1. Capital appreciation : from investing in companies experiencing growth in CF, revenue, earnings
‐ outperform other asset classes during strong economic growth
‐ underperform other asset classes during weak economic growth
2. Dividend income : 1%‐3% annually
‐ not guarantee to increase / continue in the future
‐ more stable than capital appreciation
3. Diversification : due to less than perfect correlation with other asset classes
‐ Economic crisis could decrease the risk reduction ability, due to :
+ correlation tend to increase toward 1.0 during crisis
+ volatility of assets is likely to increase
4. Inflation hedge : when company could charge customers more when input costs increase
‐ Related issues :
+ equities and inflation become negatively correlated during hyperinflation
+ equity prices are leading indicator, while inflation is lagging indicator
Client investment considerations Decision to include equities / types of equities : depend on client investment considerations, stated in Investment Poliy Statement (IPS)
High risk tolerance : growth‐oriented companies
Low risk tolerance : stable, well‐established companies
Client constrants : include Environment, Social and Governance (ESG) consideration and religious beliefs. Constraints could be addressed by :
‐ Negative screening : exclude companies / sectors do not meet requirements
‐ Positive screening : find companies / sectors that is most favorable by clients
‐ Thematic investing : screen equities based in specific theme
Equities segmentation 1. Size & Style :
‐ Size (measured by market cap) : large‐cap / mid‐cap / small‐cap companies
‐ Style (determined by company metrics ‐ PE ratio, PB ratio, dividend yield) : growth / blend / value companiesfits
‐ Advantages :
+ Better address client investment considerations in term of risk / return
+ Diversification benefits by investing across different sectors / industries
+ Able to construct relevant benchmarks for funds that invest in specific size/style category
+ Able to analyse changes in company characteristics over time
‐ Disadvantages :
+ Categories not stable over time
2. Geography : categorise international markets by stage of economic development (developed markets, emerging markets, frontier markets)
‐ Advantage : diversification across international markets
‐ Disadvantage :
+ subject to currency risk
+ overestimation of diversification benefit
3. Economic activity : group companies into sectors using market‐oriented / production‐oriented approach
‐ Market‐oriented : combine by markets served + how products are used by customers + how CF are generated (i.e.: Global Industry Classification Standards ‐ GICS)
‐ Product‐oriented : combine by products manufactured + required input in production process (i.e.: Industrial Classification Benchmark ‐ ICB ; Thomson Reuters Business
Classfication ‐ TRBC ; Russell Global Sectors Classification ‐ RGS)
‐ Advantage :
+ able to construct / analyse / compare performance benchmark based on specific sectors
+ diversification across different sectors
‐ Disadvantage : large companies may operate in multiple sectors
Types of portfolio income 1. Dividend income : subject to income / withholding tax ; less important to growth‐oriented portfolio
‐ Option stock dividend : allow investor to choose between cash payments and stock dividends. The option could be sold to other investors for money
‐ Special dividend
2. Security lending : lend security for a fee (0.2%‐0.5% in developed markets) and collateral / cash (which could generate return to lender via reinvestment). Borrower compensate
lender for any dividend payments during the loan period.
‐ Issues with security lending :
+ Lend security for short selling → ↓ stock price → ac ve manager's concern
+ Quality of borrower + Borrower's ability to return the securities
+ Loss the right to vote during loan period
‐ Issues with collateral reinvestment :
+ Subject to risks (market / credit / operational risk)
+ Additional costs (admin cost) to keep track
3. Writing option : to earn option premiums. E.g.:
‐ Covered call : sell call option on owned stock → lose upside poten al if price increases above strike price
‐ Cash‐covered put : sell put option on stock + prepare cash to pay for the stock if buyer exercises their right
4. Dividend capture : buy stock before ex‐dividend date + sell stock after ex‐dividend date. Only profitable if ↓ stock price < dividend
, Types of portfolio costs and fees 1. Management fees :
‐ to compensate for manager, pay research & analysis, computer hardware & software, compliance, processing trade
‐ based on % of assets under management
‐ due at regular time intervals
‐ vary : higher for actively management portfolio, lower for passively management portfolio
2. Performance (Incentive) fees : when portfolio outperforms a stated benchmark
‐ High‐water mark : protect investor from paying for performance twice
3. Administration fees : to pay for corporate activities
‐ Custody fees : charged when a custodian hold assets independent of portfolio manager
‐ Depository fees : charged for :
+ assist custodians with segregating portfolio assets
+ verify portfolio complance with investment limits (e.g.: leverage, cash requirements)
4. Marketing and Distribution fees : to cover :
‐ Marketing, sales and client services teams
‐ Advertise investment products / services
‐ Sponsor / Present at conferences
‐ Develop / Distribute marketing materials
‐ Fees from online platforms that offer multiple fund options
‐ Sales commissions for financial intermediary service (financial planners, brokers)
5. Trading costs : costs from buying / selling securities
‐ Explicit costs : include broker commissions, stock exchange fees, taxes
‐ Implicit costs : include bid‐ask spread, price impact from the transaction, delay costs (from not completing an entire trade due to illiquidity)
6. Investment strategy costs : cost related to chosen investment strategy
‐ Costs from Predatory trading : costs from rebalancing passive fund
Shareholder engagement 1. Definition : investors work with managers to have favorable impact on stock price via voting on corporate issues at general meetings. Main issues are :
‐ Corporate strategy : objectives, constraints, growth opportunities, resources
‐ Capital allocation : select new project, strategy for M&A, CAPEX, leverage, dividend payment and equity financing
‐ Corporate governance
‐ Compensation structure : top management remuneration, alignment with shareholder interest
‐ Composition of BOD : experience, competence, diversity, culture, effectiveness
2. Impact of shareholder engagement :
‐ Other investors not involving in the shareholder engagement also benefit from the increase in stock price, without time and cost fo the engagement
‐ Other stakeholders (e.g.: employees, customers, creditors, regulators, governments) are also affected by outcomes of shareholder engagement
3. Limitations of shareholder engagement :
‐ Costly + time‐consuming
+ Suit for active managers (influence companies in expected way to improve performance)
+ Not suit for passive managers (minimise costs)
+ Easily absorbed by large investors, over a large amount of assets
‐ May focus on ST goal (increase CF / stock price at the expense of LT goal)
‐ Risk of insider trading, due to acquisition of material non‐public information
‐ Create potential conflict of interest
4. Shareholder engagement for activist investing : Activist investors may :
‐ Propose shareholder resolutions + launch media campaign to influence vote
‐ Seek representation in BOD
‐ Launch proxy fight to achieve goal
Reasons for choosing active / 1. Confidence in manager's expert knowledge and skill
passive investment 2. Client preferences :
‐ Growth strategy → ac ve investment
‐ Value strategy → passive investment
3. Client constraints → require more ac ve approach (use screening / other techniques to meet the constraints)
4. Costs and fees : Active investment have higher cost
5. Certainty of result : Active investment's results are less certain
6. Narrowly defined benchmark → no opportuni es for ac ve managers to add value
Strategies to manage client 1. Manage a reasonable investor's expectations from the strategy. Unreasonable expectation → dissa sfac on
preferences 2. Too popular strategy → too much capital inflow → hard to find opportuni es to add value
3. Select appropriate benchmark : benchmark that contain a broad range of underlying equities with sufficient liquidity to support active management
Risks of active management 1. More costly
2. Less certain result
3. Reputation risk : from violations to ruls, regulations, client agreement and moral principles
4. Key person risk : loss of individuals who are essential to the success of the fund
5. High portfolio turnover → higher tax burden
