Handbook of Finance: Investment Management and Financial Management

Chapter 26. Investment Management: An Architecture for the Equity Market

BRUCE I. JACOBS, PhD

Principal, Jacobs Levy Equity Management

KENNETH N. LEVY, CFA

Principal, Jacobs Levy Equity Management

Abstract: The equity market may be viewed as an all-encompassing core comprising the whole investable universe (whether international or domestic) or as its constituent style subsets of large-cap growth, large-cap value, and small-cap stocks. Approaches to investment management may be classified as passive, engineered (quantitative) active, or traditional active, with risk generally increasing as one moves from passive to traditional. These basic approaches may be extended by various means, including dynamic trading across market subsets or combining long positions with some degree of short selling. Investors may benefit from taking an architectural view of the equity market that shows how its parts fit together and how they can be combined to obtain different risk-reward trade-offs.

Keywords: equity market, investment management, small-cap stocks, value stocks, growth stocks, equity core, passive management, active management, traditional management, engineered management, risk-reward trade-off, style rotation, equity market architecture, stock picking, cognitive errors, portfolio construction, short selling, long-short portfolios, residual risk

Anyone who has ever built a house knows how important it is to start out with a sound architectural design. A sound design can help ensure that the ...