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23-1 passive equity investing (3 approachs to passive equity investing (3…
23-1 passive equity investing
1 introduction
passive
investing:
any rules-based, transparent
and investable strategy that
not involve identifying
mispriced individual securities
purest form
-indexing
low cost / borad diversification /
tax efficiency
the efficient market hypothesis:
prices incorporate all relevant infor →
after cost the majority of active investor chould not consistently outperform the market
passive
manager
in the ability to trade, report and
explain the performance of portfolio
may seek market return - beta exposure
-the capital asset pricing model
not seek outperformance - alpha
3 approachs to
passive equity investing
1 pooled
investment
most convenient that easy to purchase, hold and sell
open-end
mutual funds
primary advantage - ease of investing and record keeping
primary benefits - low costs and the convenience of the fund structure
taditional shares purchased:
directly from the adviser manages the fund
through fund marketplace -
brokerage company that offer funds from different providers
through individual financial adviser
exchange
-traded
funds
-ETFs
registered funds that can be bought and sold throughout the trading day and change hands like stocls
advantages:
ease of trading / low management fees
/ tax efficiency - in-dind deliverry of stock
margin borrowing
take short positions
offer flexibility that track a wide array of indexes
require fund manager as well as an authorized participant:
the market maker and intermediary between investor and manager when shares created or redeemed
disadvantages:
buy at offer and sell at bid price
commission costs
risk of illiquid market
factor-based ETFs: provide exposure to factors
as size, value, momentum, quality, volatility and yield
the decision comes down to cost and flexibility
2
derivatives-
based
approaches
advantage: low cost, easy to implemetn and provide leverage
new set of risks: counterparty default risk / basis risk - future price not move with spot prices difficult to access for individual investors
overlay:
completion overlay:
indexed portfolio that diverged from its proper exposure
rebalancing overlay:
a portfolio's need to sell certain constituent securities and buy others
currency overlay:
hedging the return of securities that held in foreign currency back to home
*derivatives used to adjust a pre-existing portfolio to closermeeting objectives
futures and swaps can be extended by rolling the contract forward: selling the expiring contract and buying a longer dated one
index futures are cash-settled:
the counterparites exchange cash rather than the udnerlying shares
equity
index
swaps:
negotiated arrangements that two counterparites agree to exchange cash flows in the future
disadvantages:
counterparty, liquidity, interest rate and tax policy risks
advantages:
customized with respect to the underlying,
settlement frequency and maturity
add leverage or hedge a portfolio
3 separately
managed equity
index-based portfolio
trading systems
the data
subscription
the data
corporate actions
accoutign systems
broker relationships
compliance tools and teams
review holdings and weightings versus
the index each day weigh the benefits
and costs of maintaining a close match
program trading: a trategy of
buying or selling many stocks simultaneously
OMS - order management system
most index-based trade executions at the close of the business day using market-on-close orders MOC
equitizing: use futures an open-end mutual funds to transform a position (in cash) and obtain the desired equity exposure