The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition

QUESTIONS

1. Going forward, the traditional and quantitative approaches to equity portfolio management are likely to converge: Successful investors will make full use of the best available tools. In fact, many portfolio management teams already combine these two approaches. What are some alternative ways of blending the traditional and quantitative approaches, and what are some strengths of each blended approach?

2. Tracking error—the standard deviation of active returns—is a common measure of a portfolio’s ex ante risk. What are some limitations of using expected tracking error to measure the ex ante risk of an equity portfolio? When developing an equity factor risk model, why is it a good idea to include all of the return variables (the variables used to calculate stocks’ alphas) as factors in the risk model?

3. When developing an equity factor risk model, why is it a good idea to include all of the return variables (the variables used to calculate stocks’ alphas) as factors in the risk model?

4. Two widely used methods for constructing equity portfolios are stratified sampling—a type of rule-based approach—and portfolio optimization. What are some of the advantages and disadvantages of each method?

5. Transaction costs comprise two components: explicit costs, such as commissions and fees; and implicit costs, or market impact. What gives rise to market impacts costs? What are typical characteristics of stocks for which their market impact costs tend to be higher?