Equity Valuation and Portfolio Management

MONITORING

The third and final phase in the quantitative equity investment process is monitoring performance and risk. This step is important to check if any hidden biases are embedded in the portfolio and that the portfolio is performing in-line with expectations. Returning one last time to our golfer analogy, this is when the golfer is making mental notes as to what is and isn't working during the round to improve his game in the future. This step can be broken into two activities: risk management and performance attribution.

Risk Management

In risk management, the main emphasis is to make sure that the quantitative investor is buying companies consistent with her stock selection model. Returning to the retail model discussed earlier in this chapter, the model liked companies with good profit margins but had no view on the company's beta. So the quantitative investor would want to make sure that the companies included in her portfolio have high profit margins but average beta. If the portfolio started to include high-beta stocks, the quantitative investor would want to make adjustments to the process to eliminate this high-beta bias. There are many types of risk management software and techniques that can be used to detect any hidden risks embedded in the portfolio and ways to remedy those identified.

Another aspect of risk management is to make sure that the portfolio's risk level is consistent with the modeling phase. The quantitative investor wants to assure that there is ...