Equity Valuation and Portfolio Management

KEY POINTS

• The equity core and its constituent style subsets constitute the basic building blocks from which investors can construct their portfolios.
• Investors must also decide between possible investment approaches—traditional, passive, and engineered—each of which can be characterized by an underlying investment philosophy and a general level of risk.
• Investment performance reflects both breadth of inquiry, the sheer number of investment opportunities, and depth of analysis, the strength of investment insights.
• Traditional management offers depth, but strikes out with lack of breadth, susceptibility to cognitive errors, and lack of portfolio integrity.
• Passive management offers breadth, freedom from cognitive errors, and portfolio integrity, but no depth whatsoever.
• Engineered management has the ability to construct portfolios that benefit from both breadth and depth of analysis, are free of cognitive errors, and have structural integrity.
• Breadth can be expanded with the use of short selling, either in market-neutral long-short or 120-20/130-30 enhanced active strategies.
• The optimal level of residual risk for any investor will depend both on the investor's level of risk aversion and on the given manager's level of skill.
• An investor who takes less than the optimal level of residual risk or who selects less than the best manager will needlessly sacrifice return.