valueinvestment - portfollio mangement / ادارة المحافظ

ادارة المحافظ

portfollio management

Efficent markets

Efficient Markets and Portfolio Management

As noted, studies have indicated that the majority of professional money managers cannot beat a buy-and-hold policy on a risk-adjusted basis. One explanation for this generally inferior per- formance is that there are no superior analysts and the cost of research and trading forces the results of merely adequate analysis into the inferior category. Another explanation, which is favored by the authors and has some empirical support from the Value Line and analyst rec- ommendation results, is that money management firms employ both superior and inferior analysts and the gains from the recommendations by the few superior analysts are offset by the costs and the poor results derived from the recommendations of the inferior analysts.

This raises the question: Should a portfolio be managed actively or passively? 'The following discussion indicates that the decision of how to manage the portfolio (actively or passively) depends on whether the manager (or an investor) has access to superior analysts.

A portfolio manager with superior analysts or an investor who believes that he or she has the time and expertise to be a superior investor can manage a portfolio actively by looking for undervalued or oervalued securities and trading accordingly. In contrast, without access to superior ana- lysts or the time and ability to be a superior investor, you should manage passively and assume that all securities are properly priced based on their levels of risk

Portfolio Management with Superior analysts

A portfolio manager with access to super- ior analysts who have unique insights and analytical ability should follow their recommenda- tions. The superior analvsts should make investment recommendations for a certain proportion of the portfolio, and the portfolio manager should ensure that the risk preferences of the client are maintained.

Also, the superior analysts should be encouraged to concentrate their efforts in mid-cap and small-cap stocks that possess the liquidity required by institutional portfolio managers. But be- cause these stocks typically do not receive the attention given the top-tier stocks, the markets for these neglected stocks may be less efficient than the market for large well-known stocks that are being analyzed by numerous analysts.

Recall that capital markets are expected to be efficient because many investors receive new information and analyze its effect on security values. If the number of analysts following a stock differ, one could conceive of differences in the efficiency of the markets. New informa- tion on top-tier stocks is well publicized and rigorously analyzed so the price of these securities should adjust rapidly to reflect the new information. In contrast, mid-cap and small-cap stocks receive less publicity and fewer analysts follow these firms, so prices may differ from intrinsic value tor one ot two reasons. First, because of less publicity, there is less information available on these firms. Second, there are fewer analysts following these firms so the adjustment to the new information is slowed. Therefore, the possibility of finding temporarily undervalued secu- rities among these neglected stocks is greater. Again, in line with the cross-section study

results, these superior analysts should pay particular attention to the BV/MV ratio, to the size of stocks being analyzed, and to the monetary policy environment

who does not have access to superior analysts

should proceed as follows. First, he or she should measure the risk preferences of his or her clients, then build portfolio to match this risk level by investing a certain proportion of the portfolio in risky assets and the rest in a risk-free asset, as discussed in Chapter 8.

The risky asset portfolio must be completely diversified on a global basis so it moves consis- tently with the world market. In this context, proper diversification means eliminating all unsys- tematic (unique) variability. In our prior discussion, it was estimated that it required about 20 securities to gain most of the benefits (more than 90 percent) of a completely diversified portfo- lio. More than 100 stocks are required for complete diversification. To decide how many securi- ties to actually include in your global portfolio, you must balance the added benefits of complete worldwide diversification against the costs of research for the additional stocks.

Finally, you should minimize transaction costs. Assuming that the portfolio is completely diversified and is structured for the desired risk level, excessive transaction costs that do not generate added returns will detract from your expected rate of return. Three factors are in- volved in minimizing total transaction costs:

1. Minimize taxes. Methods of accomplishing this objective vary, but it should receive prime consideration. 2. Reduce trading turnover. Trade only to sell overvalued stock out of the portfolio or add undervalued stock while maintaining a given risk level. 3. When you trade, minimize liquidity costs by trading relatively liquid stocks. To accomplish this, submit limit orders to buy or sell several stocks at prices that approximate the market-makers quote. That is, you would put in limit orders to buy stock at the bid price or sell at the ask price. The stock bought or sold first is the most liquid one; all other orders should be withdrawn.

In

summary, if you lack access to superior analysts, you should do the following:

1. Determine and quantify your risk preferences., 2. Construct the appropriate risk portfolio by dividing the total portfolio between risk-free assets and a risky asset portfolio, 3. Diversify completely on a global basis to eliminate all unsystematic risk, 4. Maintain the specified risk level by rebalancing when necessary, 5. Minimize total transaction costs