Last revised: 7 September 2004

 

Equity Portfolio Management                                                                                                    Fall 2004

Applications of Portfolio Analysis (B40.3181.10)

 

Andrew W. Alford

aalford@stern.nyu.edu

 

Class:               Tuesday 6:00p – 9:00p   (28 September – 2 November)

Office hours:     Tuesday 5:15p – 5:45p   (5 October – 2 November)

 

Description

 

This course provides a rigorous introduction to active equity portfolio management from a practitioner’s perspective.  The course is aimed at students interested in a career in investment management, including equity research, portfolio management, equity trading, risk management, product strategy, and investment consulting.  The major topics covered in the course are strategic asset allocation, including risk budgeting and the role of benchmarks; forecasting returns, risks, and transaction costs; portfolio construction, with a focus on optimization with factor risk models and the effects of constraints; equity trading; and performance attribution.  The course highlights recent trends in the investment management industry, and introduces terminology familiar to investment professionals.

 

The course assumes an understanding of modern portfolio theory, the CAPM, financial accounting, and basic statistics, especially regression analysis and hypothesis testing.

 

Materials

 

There is a packet of research articles for sale in the bookstore.  There is no required text book.  If you have an interest in learning more about the topics covered in this course, I suggest you read select portions of the following two books:

 

Grinold, Richard C. and Ronald N. Kahn.  2000.  Active portfolio management: A quantitative approach for providing superior returns and controlling risk.  Second edition.  McGraw-Hill.

 

Litterman, Bob.  2003.  Modern investment management: An equilibrium approach.  John Wiley & Sons.

 

Grading

 

The course grade will be based on class participation (20%), homework assignments (20%), and an in-class final exam (60%).  The distribution of course grades will follow the Department of Finance Guidelines: A (20–25%), B (55–70%), and C and below (10–20%).

 

There will be five homework assignments.  Your aggregate homework score will be based on the four assignments with the highest scores (i.e., I will drop the lowest score).  You may work in teams of 1–3 people, and you may change the composition of your team from assignment to assignment.  All students on a homework team must actively contribute to the solution of each question, and each team member’s name must appear on the solution sheet when it is turned in.  Homework is due promptly at the beginning of lecture.  Late homework will not be accepted.  If you are unable to submit your homework in class, you may submit your solution electronically.

 

The final exam is comprehensive.  It will cover material from class, the assigned readings, and the homework assignments.  The final exam is closed book, but you may bring a single, letter-sized sheet of notes (front and back) with you to the exam.  You may also bring a calculator, but you may not share calculators with other students.  The final exam will be held during session 6, Tuesday 2 November 2004.  The exam will begin promptly at 6:30p.  You will have two hours.

 

Session 1 — Tuesday 28 September 2004

 

Course overview

  • Goals
  • Topics
  • Structure

 

Overview of the investment management business

  • Investment management within the financial services sector
  • Major investment management products and services
  • Functional areas of an investment management firm
  • Steps in the equity portfolio management process

 

Strategic asset allocation

  • Asset classes
  • Risk budgeting
  • Benchmarks
  • Portable alpha strategies
  • Investment mandate
  • Rebalancing policy

 

Reading assignment

  • Litterman, chapter 23: Equity portfolio management, by Andrew Alford, Robert Jones, and Terence Lim.
  • Kahn, Ronald N.  2002.  What plan sponsors need from their active equity managers.  Equity Portfolio Construction.  AMIR Conference Proceedings (September):  57–62.

 

Additional (optional) reading

  • Litterman, chapter 9: Issues in strategic asset allocation, by Kurt Winkelmann.
  • Litterman, chapter 13: Developing an optimal active risk budget, by Kurt Winkelmann.
  • Litterman, chapter 14: Budgeting risk along the active risk spectrum, by Andrew Alford, Robert Jones, and Kurt Winkelmann.
  • Litterman, chapter 15: Risk management and risk budgeting at the total fund level, by Jason Gottlieb.

 

Homework assignment no. 1 (due 6:00p, Tuesday 5 October 2004)

 

Session 2 — Tuesday 5 October 2004

 

Portfolio Construction

  • Optimization
  • Constraints
  • Rebalancing

 

Risk models

  • Distribution of stock returns
  • Factor risk models
  • Monitoring

 

Reading assignment

  • Madhavan, Ananth and Jian Yang.  2003.  Practical risk analysis.  The Journal of Portfolio Management (Fall): 73–85.

 

Additional (optional) reading

  • Grinold and Kahn, chapter 3: Risk.
  • Grinold and Kahn, chapter 14: Portfolio construction.
  • Litterman, chapter 16: Covariance matrix estimation, by Giorgio De Santis, Bob Litterman, Adrien Vesval, and Kurt Winkelmann.
  • Litterman, chapter 20: Equity risk factor models, by Peter Zangari.

 

Homework assignment no. 2 (due 6:00p, Tuesday 12 October 2004)

 

Session 3 — Tuesday 12 October 2004

 

Return models

  • Anomalies
  • Behavioral finance
  • Model misspecification
  • Data mining
  • Statistical vs. economic significance

 

Reading assignment

  • Chan, Louis K.C., Narasimhan Jegadeesh, and Joseph Lakonishok.  1999.  The profitability of momentum strategies.  Financial Analysts Journal (November/December): 80–90.
  • Dimson, Elroy, Stefan Nagel, and Garrett Quigley.  Capturing the value premium in the United Kingdom.  Financial Analysts Journal (November/December): 35–45.
  • Sloan, Richard G.  1996.  Do stock prices fully reflect information in accruals and cash flows about future earnings?  The Accounting Review 71 (3): 289–315.

 

Additional (optional) reading

  • Bernard, Vic and Jacob Thomas.  1990.  Evidence that stock prices do not fully reflect the implications of current earnings for future earnings.  Journal of Accounting and Economics 13: 305–340.
  • Desai, Hemang, Bing Liang, and Ajai K. Singh.  2000.  Do all-stars shine?  Evaluation of analyst recommendations.  Financial Analysts Journal (May/June): 20–29.
  • Jegadeesh, N. and S. Titman.  1993.  Returns to buying winners and selling losers:  Implications for stock market efficiency.  Journal of Finance 48 (1): 65–91.
  • Lakonishok, Josef, Andrei Shleifer, and Robert W. Vishny.  1994.  Contrarian investment, extrapolation, and risk.  Journal of Finance 49 (5): 1541–1578.
  • Michaely, R., R.H. Thaler, and K.L. Womack.  1995.  Price reactions to dividend initiations and omissions:  Overreaction or drift?  Journal of Finance 50 (2): 573–608.
  • Rouwenhorst, K. Geert.  1998.  International momentum strategies.  Journal of Finance 53 (1): 267–284.

 

Homework assignment no. 3 (due 6:00p, Tuesday 19 October 2004)

 

Session 4 — Tuesday 19 October 2004

 

Return models (continued)

  • Methods for testing signals
  • Mapping signals into expected returns

 

Reading assignment

  • Grinold, Richard C.  1989.  The fundamental law of active management.  The Journal of Portfolio Management (Spring): 30–37.

 

Additional (optional) reading

  • Lo, Andrew W. and A. Craig MacKinlay.  1990.  Data-snooping biases in tests of financial asset pricing models.  Review of Financial Studies 17 (3): 431–467.
  • McQueen, Grant and Steven Thorley.  1999.  Mining Fool’s Gold.  Financial Analysts Journal (March/April): 61–72.

 

Homework assignment no. 4 (due 6:00p, Tuesday 26 October 2004)

 

Session 5 — Tuesday 26 October 2004

 

Trading

  • Determinants and components of transaction costs
  • Trading approaches
  • Transition management
  • Operational risk
  • Monitoring

 

Performance analysis

  • Performance metrics
  • Style analysis
  • Factor models
  • Variance analysis

 

Manager selection

  • Consultants
  • Criteria
  • Horizon

 

Trends

  • Sources of equity research
  • Alpha vs. beta

 

Reading assignment

  • Perold, André F.  1988.  The implementation shortfall:  Paper versus reality.  The Journal of Portfolio Management (Spring): 4–9.
  • Sofianos, George and Jeff Bacidore.  2002.  Evaluating execution quality for large orders.  Goldman Sachs Derivatives and Trading Research.  24 October.
  • Bacidore, Jeff and George Sofianos.  2003.  Choosing the best order execution strategy.  Goldman Sachs Derivatives and Trading Research.  23 January.

 

Additional (optional) reading

  • Bernstein, Peter.  2003.  Points of inflection: Investment Management Tomorrow.  Financial Analysts Journal (July/August): 18–23.
  • Grinold and Kahn, chapter 16: Transactions costs, turnover, and trading.
  • Grinold and Kahn, chapter 17: Performance analysis.
  • Litterman, chapter 17: Risk monitoring and performance measurement, by Jacob Rosengarten and Peter Zangari.
  • Litterman, chapter 19: Return attribution, by Peter Zangari.
  • Madhavan, Ananth.  2002.  Market microstructure: A practitioner’s guide.  Financial Analysts Journal (September/October): 28–42.

 

Homework assignment no. 5 (due 6:00p, Tuesday 2 November 2004)

 

Session 6 — Tuesday 2 November 2004

 

Final exam:

  • Two-hours: 6:30p – 8:30p
  • Comprehensive (sessions 1–5, readings, homework assignments)
  • One sheet of notes (front and back, letter-sized)
  • Calculator (but may not share calculators)