Fin Fin 2802: 2802: Investments Investments Spring, Spring, 2010 2010 Dragon Dragon Tang Tang Lecture 19 Practical Portfolio Management April 8, 2010 Readings: Chapter 27 Practice Problem Sets: 1,2 FIN 2802, Spring 10 - Tang
Chapter 27: Practical Portfolio Management 1 Overview Overview Treynor-Black model Optimization using analysts forecasts of superior performance Adjusting model for tracking error Adjusting model for analyst forecast error Black-Litterman model FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 2
Table Table27.1 27.1Construction Constructionand andProperties Propertiesof ofthe theOptimal OptimalRisky RiskyPortfolio Portfolio (properties (properties1-5) 1-5) FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 3
Table Table27.1 27.1Construction Constructionand andProperties Propertiesof ofthe theOptimal OptimalRisky RiskyPortfolio Portfolio (properties (properties6-11) 6-11) FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management
4 Table Table27.2 27.2Stock StockPrices Pricesand andAnalysts AnalystsTarget TargetPrices Prices for forJune June1, 1,2006 2006 FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management
5 Figure Figure27.1 27.1Rates Ratesof ofReturn Returnon onthe theS&P S&P500 500(GSPC) (GSPC)and andthe theSix SixStocks Stocks June June2005
2005May May2006 2006 FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 6 Table Table27.3 27.3The TheOptimal OptimalRisky RiskyPortfolio Portfoliowith withthe theAnalysts AnalystsNew
NewForecasts Forecasts FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 7 Table Table27.4 27.4The TheOptimal OptimalRisk RiskPortfolio Portfoliowith withConstraint Constraint on onthe
theActive ActivePortfolio Portfolio(WA (WA<<1) 1) FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 8 Figure Figure27.2 27.2Reduced ReducedEfficiency Efficiencywhen whenBenchmark BenchmarkIs IsLowered
Lowered FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 9 Table Table27.5 27.5The TheOptimal OptimalRisky RiskyPortfolio Portfoliowith withthe theAnalysts AnalystsNew NewForecasts Forecasts
(benchmark (benchmarkrisk riskconstrained constrainedto to3.85%) 3.85%) FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 10 Figure Figure 27.3 27.3 Histogram Histogram of of the the Alpha Alpha Forecast
Forecast FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 11 Figure Figure27.4 27.4Organizational OrganizationalChart Chartfor forPortfolio PortfolioManagement Management FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management
12 Steps Steps in in the the Black-Litterman Black-Litterman Model Model Step 1: Estimate the covariance matrix from historical data Step 2: Determine a baseline forecast Step 3: Integrating the managers private views Step 4: Developing revised (posterior) expectations Step 5: Apply portfolio optimization FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management
13 Figure Figure27.5 27.5Sensitivity Sensitivityof ofBlack BlackLitterman LittermanPortfolio PortfolioPerformance Performance to toConfidence ConfidenceLevel Level(view (viewisiscorrect) correct) FIN 2802, Spring 10 - Tang
Chapter 27: Practical Portfolio Management 14 Figure Figure27.6 27.6Sensitivity Sensitivityof ofBlack BlackLitterman LittermanPortfolio PortfolioPerformance Performance to toConfidence ConfidenceLevel Level(view (viewisisfalse) false)
FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 15 Table Table27.6 27.6M-Square M-Squarefor forthe thePortfolio, Portfolio,Actual ActualForecasts Forecasts FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management
16 Table Table 27.7 27.7 M-Square M-Square for forthe theSimulated Simulated Portfolios Portfolios FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 17 Concluding ConcludingRemarks
Remarkson onthe theTheory Theoryof ofActive ActiveInvestments Investments The gap between theory and practice has been narrowing in recent years The CFA is expanding knowledge base in the industry Specific lack of application of the Treynor-Black model may be related to lack of application of adjusting for analysts errors FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 18
Summary Summary Treynor-Black model Black-Litterman Model Next Class: Performance Evaluation FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 19
