Fin 2802: Investments Spring, 2010 Dragon Tang Lecture 19 Practical Portfolio Management April 8, 2010 Readings: Chapter 27 Practice Problem Sets: 1,2 Chapter 27: Practical Portfolio Management FIN 2802, Spring 10 - Tang

Chapter 27: Practical Portfolio Management 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 Chapter 27: Practical Portfolio Management FIN 2802, Spring 10 - Tang

Chapter 27: Practical Portfolio Management Table 27.1 Construction and Properties of the Optimal Risky Portfolio (properties 1-5) Chapter 27: Practical Portfolio Management FIN 2802, Spring 10 - Tang

Chapter 27: Practical Portfolio Management Table 27.1 Construction and Properties of the Optimal Risky Portfolio (properties 6-11) Chapter 27: Practical Portfolio Management FIN 2802, Spring 10 - Tang

Table 27.2 Stock Prices and Analysts’ Target Prices for June 1, 2006 Chapter 27: Practical Portfolio Management FIN 2802, Spring 10 - Tang

Chapter 27: Practical Portfolio Management Figure 27.1 Rates of Return on the S&P 500 (GSPC) and the Six Stocks June 2005 – May 2006 Chapter 27: Practical Portfolio Management FIN 2802, Spring 10 - Tang

Chapter 27: Practical Portfolio Management Table 27.3 The Optimal Risky Portfolio with the Analysts’ New Forecasts Chapter 27: Practical Portfolio Management FIN 2802, Spring 10 - Tang

Chapter 27: Practical Portfolio Management Table 27.4 The Optimal Risk Portfolio with Constraint on the Active Portfolio (WA < 1) Chapter 27: Practical Portfolio Management FIN 2802, Spring 10 - Tang

Figure 27.2 Reduced Efficiency when Benchmark Is Lowered Chapter 27: Practical Portfolio Management FIN 2802, Spring 10 - Tang

Chapter 27: Practical Portfolio Management Table 27.5 The Optimal Risky Portfolio with the Analysts’ New Forecasts (benchmark risk constrained to 3.85%) Chapter 27: Practical Portfolio Management FIN 2802, Spring 10 - Tang

Figure 27.3 Histogram of the Alpha Forecast Chapter 27: Practical Portfolio Management FIN 2802, Spring 10 - Tang

Figure 27.4 Organizational Chart for Portfolio Management Chapter 27: Practical Portfolio Management FIN 2802, Spring 10 - Tang

Steps in the Black-Litterman Model Step 1: Estimate the covariance matrix from historical data Step 2: Determine a baseline forecast Step 3: Integrating the manager’s private views Step 4: Developing revised (posterior) expectations Step 5: Apply portfolio optimization Chapter 27: Practical Portfolio Management FIN 2802, Spring 10 - Tang

Chapter 27: Practical Portfolio Management Figure 27.5 Sensitivity of Black Litterman Portfolio Performance to Confidence Level (view is correct) Chapter 27: Practical Portfolio Management FIN 2802, Spring 10 - Tang

Chapter 27: Practical Portfolio Management Figure 27.6 Sensitivity of Black Litterman Portfolio Performance to Confidence Level (view is false) Chapter 27: Practical Portfolio Management FIN 2802, Spring 10 - Tang

Table 27.6 M-Square for the Portfolio, Actual Forecasts Chapter 27: Practical Portfolio Management FIN 2802, Spring 10 - Tang

Table 27.7 M-Square for the Simulated Portfolios Chapter 27: Practical Portfolio Management FIN 2802, Spring 10 - Tang

Concluding Remarks on the Theory of Active 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 Chapter 27: Practical Portfolio Management FIN 2802, Spring 10 - Tang

Chapter 27: Practical Portfolio Management Summary Treynor-Black model Black-Litterman Model Next Class: Performance Evaluation Chapter 27: Practical Portfolio Management FIN 2802, Spring 10 - Tang