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Chapter 15 Revision of the Equity Portfolio Portfolio Construction, Management, & Protection , 5e, Robert A. Strong Copyri...
<ul><li>An individual can make a difference; a team can make a miracle </li></ul><ul><li>1980 U.S. Olympic hockey team </l...
Introduction <ul><li>Portfolios need maintenance and periodic revision: </li></ul><ul><ul><li>Because the needs of the ben...
Active Management versus Passive Management <ul><li>An  active management  policy is one in which the composition of the p...
The Manager’s Choices <ul><li>Leave the Portfolio Alone </li></ul><ul><li>Rebalance the Portfolio </li></ul><ul><li>Asset ...
Leave the Portfolio Alone <ul><li>A  buy and hold strategy  means that the portfolio manager hangs on to its original inve...
Rebalance the Portfolio <ul><li>Rebalancing  a portfolio is the process of periodically adjusting it to maintain the origi...
Constant Mix Strategy <ul><li>The  constant mix strategy : </li></ul><ul><ul><li>Is one in which the manager makes adjustm...
Constant Mix Strategy (cont’d) <ul><li>Example </li></ul><ul><li>A portfolio has a market value of $2 million. The investm...
Constant Mix Strategy (cont’d) <ul><li>Example (cont’d) </li></ul><ul><li>What dollar amount of stock should the portfolio...
Constant Mix Strategy (cont’d) <ul><li>Example (cont’d) </li></ul><ul><li>Solution:  a 60 percent/40 percent asset allocat...
Constant Proportion  Portfolio Insurance <ul><li>A  constant proportion portfolio insurance  (CPPI) strategy requires the ...
Constant Proportion  Portfolio Insurance (cont’d) <ul><li>Example </li></ul><ul><li>A portfolio has a market value of $2 m...
Constant Proportion  Portfolio Insurance (cont’d) <ul><li>Example (cont’d) </li></ul><ul><li>Solution:  $600,000 should be...
Constant Proportion  Portfolio Insurance (cont’d) <ul><li>Example (cont’d) </li></ul><ul><li>Solution:  The desired equity...
Relative Performance of Constant Mix and CPPI <ul><li>A constant mix strategy  sells  stock as it rises </li></ul><ul><li>...
Relative Performance of Constant Mix and CPPI (cont’d) <ul><li>In a  rising market , the CPPI strategy outperforms constan...
Relative Performance of Constant Mix and CPPI (cont’d) <ul><li>The relative performance of the strategies depends on the p...
Rebalancing Within the  Equity Portfolio <ul><li>Constant Proportion </li></ul><ul><li>Constant Beta Portfolio </li></ul><...
Constant Proportion <ul><li>A  constant proportion strategy  within an equity portfolio requires maintaining the same perc...
Constant Proportion (cont’d) <ul><li>Example </li></ul><ul><li>An investor attempts to invest approximately one third of f...
Constant Proportion (cont’d) <ul><li>Example (cont’d) </li></ul><ul><li>After one quarter, the portfolio values are as sho...
Constant Proportion (cont’d) <ul><li>Example (cont’d) </li></ul><ul><li>Solution:  The worksheet below shows a possible re...
Constant Beta Portfolio <ul><li>A  constant beta portfolio  requires maintaining the same portfolio beta </li></ul><ul><li...
Change the  Portfolio Components <ul><li>Changing the portfolio components is another portfolio revision alternative </li>...
Indexing <ul><li>Indexing  is a form of portfolio management that attempts to mirror the performance of a market index </l...
Tactical Asset Allocation <ul><li>What Is Tactical Asset Allocation? </li></ul><ul><li>How TAA Can Benefit a Portfolio </l...
Tactical Asset Allocation <ul><li>Tactical asset allocation (TAA)  managers: </li></ul><ul><ul><li>Seek to improve the per...
Definition (cont’d) <ul><li>TAA attempts to take advantage of short-term deviations from long-term trends </li></ul><ul><l...
Intuitive versus  Quantitative Techniques <ul><li>In the intuitive approach, decisions are based on personal opinion and g...
Overview of the Technique
Policy Decisions <ul><li>Policy decisions involve: </li></ul><ul><ul><li>Deciding to use a TAA program in the first place ...
Strategy <ul><li>There are three alternative strategic functions: </li></ul><ul><ul><li>Static strategy  maintains a stati...
How TAA Can  Benefit a Portfolio <ul><li>The goal of an anticipatory strategy is to outperform the portfolio without TAA <...
How TAA Can  Benefit a Portfolio (cont’d) Source: Ensign Peak Advisors, Inc., Salt Lake City, UT 84150.
Designing a TAA Program <ul><li>Before implementing a TAA program, a fund manager must establish: </li></ul><ul><ul><li>Th...
Designing a  TAA Program (cont’d) <ul><li>Before implementing a TAA program, a fund manager must establish (cont’d): </li>...
Efficient Market Implications <ul><li>TAA programs implicitly assume it is possible to outperform a buy-and-hold strategy ...
Impact of Transaction Costs <ul><li>The portfolio incurs trading fees each time a trade occurs </li></ul><ul><li>If the ma...
Costs of Revision <ul><li>Costs of revising a portfolio can: </li></ul><ul><ul><li>Be direct dollar costs </li></ul></ul><...
Commissions <ul><li>Investors pay commissions both to buy and to sell shares </li></ul><ul><li>Commissions at a brokerage ...
Commissions (cont’d) <ul><li>The commission on a trade is split between the broker and the firm for which the broker works...
Commissions (cont’d) <ul><li>Discount brokerage firms : </li></ul><ul><ul><li>Offer substantially reduced commission rates...
Transfer Taxes <ul><li>Transfer taxes are: </li></ul><ul><ul><li>Imposed by some states on the transfer of securities </li...
Market Impact <ul><li>The  market impact  of placing the trade is the change in market price purely because of executing t...
Management Time <ul><li>Most portfolio managers handle more than one account </li></ul><ul><li>Rebalancing several dozen p...
Tax Implications <ul><li>Individual investors and corporate clients must pay taxes on the realized capital gains associate...
Window Dressing <ul><li>Window dressing  refers to cosmetic changes made to a portfolio near the end of a reporting period...
Rising Importance  of Trading Fees <ul><li>Flippancy regarding commission costs is unethical and sometimes illegal </li></...
Contributions to the Portfolio <ul><li>Periodic additional contributions to the portfolio from internal or external source...
When Do You Sell Stock? <ul><li>Knowing when to sell a stock is a very difficult part of investing </li></ul><ul><li>Behav...
Rebalancing <ul><li>Rebalancing can cause the portfolio manager to sell shares even if they are not doing poorly </li></ul...
Upgrading <ul><li>Investors should sell shares when their investment potential has deteriorated to the extent that they no...
Sale of a Stock Via Stop Orders <ul><li>Stop orders : </li></ul><ul><ul><li>Are usually used to sell but can be used to bu...
Using Stops to Minimize Losses <ul><li>Stop-loss orders can be used to minimize losses </li></ul><ul><ul><li>e.g., you bou...
Using Stops to Protect Profits <ul><li>Stop orders can be used to protect profits </li></ul><ul><ul><li>e.g., a stock you ...
Change in Client Objectives <ul><li>The client’s investment objectives may change occasionally: </li></ul><ul><ul><li>e.g....
Change in Market Conditions <ul><li>Many fund managers seek to actively time the market </li></ul><ul><li>When a portfolio...
Buy-Outs <ul><li>A firm may be making a  tender offer  for one of the portfolio holdings </li></ul><ul><ul><li>i.e., anoth...
Caprice <ul><li>Portfolio managers: </li></ul><ul><ul><li>Should be careful about making unnecessary trades </li></ul></ul...
Final Thoughts <ul><li>Hindsight is an inappropriate perspective for investment decision making </li></ul><ul><ul><li>Ever...
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Chapter 15

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Chapter 15

  1. 1. Chapter 15 Revision of the Equity Portfolio Portfolio Construction, Management, & Protection , 5e, Robert A. Strong Copyright ©2009 by South-Western, a division of Thomson Business & Economics. All rights reserved.
  2. 2. <ul><li>An individual can make a difference; a team can make a miracle </li></ul><ul><li>1980 U.S. Olympic hockey team </li></ul>
  3. 3. Introduction <ul><li>Portfolios need maintenance and periodic revision: </li></ul><ul><ul><li>Because the needs of the beneficiary will change </li></ul></ul><ul><ul><li>Because the relative merits of the portfolio components will change </li></ul></ul><ul><ul><li>To keep the portfolio in accordance with the investment policy statement and investment strategy </li></ul></ul>
  4. 4. Active Management versus Passive Management <ul><li>An active management policy is one in which the composition of the portfolio is dynamic </li></ul><ul><ul><li>The portfolio manager periodically changes: </li></ul></ul><ul><ul><ul><li>The portfolio components or </li></ul></ul></ul><ul><ul><ul><li>The components’ proportion within the portfolio </li></ul></ul></ul><ul><li>A passive management strategy is one in which the portfolio is largely left alone </li></ul>
  5. 5. The Manager’s Choices <ul><li>Leave the Portfolio Alone </li></ul><ul><li>Rebalance the Portfolio </li></ul><ul><li>Asset Allocation and Rebalancing within the Aggregate Portfolio </li></ul><ul><li>Rebalancing within the Equity Portion </li></ul><ul><li>Change the Portfolio Components </li></ul><ul><li>Indexing </li></ul>
  6. 6. Leave the Portfolio Alone <ul><li>A buy and hold strategy means that the portfolio manager hangs on to its original investments </li></ul><ul><li>Academic research shows that portfolio managers often fail to outperform a simple buy and hold strategy on a risk-adjusted basis </li></ul><ul><ul><li>e.g., Barber and Odean show that investors who trade the most have the lowest gross and net returns </li></ul></ul>
  7. 7. Rebalance the Portfolio <ul><li>Rebalancing a portfolio is the process of periodically adjusting it to maintain the original conditions </li></ul>
  8. 8. Constant Mix Strategy <ul><li>The constant mix strategy : </li></ul><ul><ul><li>Is one in which the manager makes adjustments to maintain the relative weighting of the asset classes within the portfolio as their prices change </li></ul></ul><ul><ul><li>Requires the purchase of securities that have performed poorly and the sale of securities that have performed the best </li></ul></ul>
  9. 9. Constant Mix Strategy (cont’d) <ul><li>Example </li></ul><ul><li>A portfolio has a market value of $2 million. The investment policy statement requires a target asset allocation of 60 percent stock and 40 percent bonds. </li></ul><ul><li>The initial portfolio value and the portfolio value after one quarter are shown on the next slide. </li></ul>
  10. 10. Constant Mix Strategy (cont’d) <ul><li>Example (cont’d) </li></ul><ul><li>What dollar amount of stock should the portfolio manager buy to rebalance this portfolio? What dollar amount of bonds should he sell? </li></ul>$1,100,000 $1,400,000 56%/44% $2,500,000 1 Apr $800,000 $1,200,000 60%/40% $2,000,000 1 Jan Bonds Stock Actual Allocation Portfolio Value Date
  11. 11. Constant Mix Strategy (cont’d) <ul><li>Example (cont’d) </li></ul><ul><li>Solution: a 60 percent/40 percent asset allocation for a $2.5 million portfolio means the portfolio should contain $1.5 million in stock and $1 million in bonds. Thus, the manager should buy $100,000 worth of stock and sell $100,000 worth of bonds. </li></ul>
  12. 12. Constant Proportion Portfolio Insurance <ul><li>A constant proportion portfolio insurance (CPPI) strategy requires the manager to invest a percentage of the portfolio in stocks: </li></ul><ul><li>$ in stocks = Multiplier × (Portfolio value – Floor value) </li></ul>
  13. 13. Constant Proportion Portfolio Insurance (cont’d) <ul><li>Example </li></ul><ul><li>A portfolio has a market value of $2 million. The investment policy statement specifies a floor value of $1.7 million and a multiplier of 2. </li></ul><ul><li>What is the dollar amount that should be invested in stocks according to the CPPI strategy? </li></ul>
  14. 14. Constant Proportion Portfolio Insurance (cont’d) <ul><li>Example (cont’d) </li></ul><ul><li>Solution: $600,000 should be invested in stock: </li></ul><ul><li> $ in stocks = 2.0 × ($2,000,000 – $1,700,000) </li></ul><ul><li>= $600,000 </li></ul><ul><li>If the portfolio value is $2.2 million one quarter later, with $650,000 in stock, what is the desired equity position under the CPPI strategy? What is the ending asset mix after rebalancing? </li></ul>
  15. 15. Constant Proportion Portfolio Insurance (cont’d) <ul><li>Example (cont’d) </li></ul><ul><li>Solution: The desired equity position after one quarter should be: </li></ul><ul><li> $ in stocks = 2.0 × ($2,200,000 – $1,700,000) </li></ul><ul><li>= $1,000,000 </li></ul><ul><li>The portfolio manager should move $350,000 into stock. The resulting percentage would be: $1,000,000/$2,200,000 = 45.5% </li></ul>
  16. 16. Relative Performance of Constant Mix and CPPI <ul><li>A constant mix strategy sells stock as it rises </li></ul><ul><li>A CPPI strategy buys stock as it rises </li></ul>
  17. 17. Relative Performance of Constant Mix and CPPI (cont’d) <ul><li>In a rising market , the CPPI strategy outperforms constant mix </li></ul><ul><li>In a declining market , the CPPI strategy outperforms constant mix </li></ul><ul><li>In a flat market , neither strategy has an obvious advantage </li></ul><ul><li>In a volatile market , the constant mix strategy outperforms CPPI </li></ul>
  18. 18. Relative Performance of Constant Mix and CPPI (cont’d) <ul><li>The relative performance of the strategies depends on the performance of the market during the evaluation period </li></ul><ul><li>In the long run, the market will probably rise, which favors CPPI </li></ul><ul><li>In the short run, the market will be volatile, which favors constant mix </li></ul>
  19. 19. Rebalancing Within the Equity Portfolio <ul><li>Constant Proportion </li></ul><ul><li>Constant Beta Portfolio </li></ul><ul><li>Change the Portfolio Components </li></ul><ul><li>Indexing </li></ul>
  20. 20. Constant Proportion <ul><li>A constant proportion strategy within an equity portfolio requires maintaining the same percentage investment in each stock </li></ul><ul><ul><li>May be mitigated by avoidance of odd lot transactions </li></ul></ul><ul><li>Constant proportion rebalancing requires selling winners and buying losers </li></ul>
  21. 21. Constant Proportion (cont’d) <ul><li>Example </li></ul><ul><li>An investor attempts to invest approximately one third of funds in each of the stocks. Consider the following information: </li></ul>100.00 $28,250 Total 35.40 10,000 200 50.00 YH 33.45 9,450 700 13.50 HG 31.15 8,800 400 22.00 FC % of Total Portfolio Value Shares Price Stock
  22. 22. Constant Proportion (cont’d) <ul><li>Example (cont’d) </li></ul><ul><li>After one quarter, the portfolio values are as shown below. Recommend specific actions to rebalance the portfolio in order to maintain the constant proportion in each stock. </li></ul>100.00 $36,500 Total 49.32 18,000 200 90.00 YH 28.77 10,500 700 15.00 HG 21.92 8,000 400 20.00 FC % of Total Portfolio Value Shares Price Stock
  23. 23. Constant Proportion (cont’d) <ul><li>Example (cont’d) </li></ul><ul><li>Solution: The worksheet below shows a possible revision which requires an additional investment of $1,000: </li></ul>100.00 36.00 32.00 32.00 % of Portfolio Sell 50 Buy 100 Buy 200 Action $37,500 $36,500 Total 13,500 18,000 200 90.00 YH 12,000 10,500 700 15.00 HG 12,000 8,000 400 20.00 FC Value After Value Before Shares Price Stock
  24. 24. Constant Beta Portfolio <ul><li>A constant beta portfolio requires maintaining the same portfolio beta </li></ul><ul><li>It is more likely to have requirements that beta be within some given range </li></ul><ul><li>To increase or reduce the portfolio beta, the portfolio manager can: </li></ul><ul><ul><li>Reduce or increase the amount of cash in the portfolio </li></ul></ul><ul><ul><li>Purchase stocks with higher or lower betas than the target figure </li></ul></ul><ul><ul><li>Sell high-beta stocks or low-beta stocks </li></ul></ul><ul><ul><li>Buy high-beta stocks or low-beta stocks </li></ul></ul>
  25. 25. Change the Portfolio Components <ul><li>Changing the portfolio components is another portfolio revision alternative </li></ul><ul><li>Events sometimes deviate from what the manager expects: </li></ul><ul><ul><li>The manager might sell an investment turned sour </li></ul></ul><ul><ul><li>The manager might purchase a potentially undervalued replacement security </li></ul></ul>
  26. 26. Indexing <ul><li>Indexing is a form of portfolio management that attempts to mirror the performance of a market index </li></ul><ul><ul><li>e.g., the S&P 500 or the Russell 1000 </li></ul></ul><ul><li>Index funds eliminate concerns about outperforming the market </li></ul><ul><li>The tracking error refers to the extent to which a portfolio deviates from its intended behavior </li></ul>
  27. 27. Tactical Asset Allocation <ul><li>What Is Tactical Asset Allocation? </li></ul><ul><li>How TAA Can Benefit a Portfolio </li></ul><ul><li>Designing a TAA Program </li></ul><ul><li>Caveats Regarding TAA Performance </li></ul><ul><li>Costs of Revision </li></ul><ul><li>Contributions to the Portfolio </li></ul>
  28. 28. Tactical Asset Allocation <ul><li>Tactical asset allocation (TAA) managers: </li></ul><ul><ul><li>Seek to improve the performance of their funds by shifting the relative proportion of their investments into and out of asset classes as the relative prospects of those asset classes change </li></ul></ul><ul><li>For example, shift to stocks if stocks are expected to outperform bonds </li></ul>
  29. 29. Definition (cont’d) <ul><li>TAA attempts to take advantage of short-term deviations from long-term trends </li></ul><ul><li>The most difficult part of TAA is asset class appraisal </li></ul><ul><ul><li>The process of determining the relative merits of the various asset classes given current economic conditions </li></ul></ul>
  30. 30. Intuitive versus Quantitative Techniques <ul><li>In the intuitive approach, decisions are based on personal opinion and gut feeling </li></ul><ul><ul><li>Suffers from hindsight bias </li></ul></ul><ul><ul><ul><li>Portfolio managers remember the times they were correct </li></ul></ul></ul><ul><li>In the quantitative approach, managers use an analytical assessment and a system for implementing precise portfolio changes </li></ul><ul><ul><li>e.g., use the gap between the S&P 500 dividend yield and the average yield on AAA corporate bonds </li></ul></ul>
  31. 31. Overview of the Technique
  32. 32. Policy Decisions <ul><li>Policy decisions involve: </li></ul><ul><ul><li>Deciding to use a TAA program in the first place </li></ul></ul><ul><ul><li>Establishing the extent to which the program will be employed </li></ul></ul><ul><ul><li>Determining the number of asset classes to employ </li></ul></ul>
  33. 33. Strategy <ul><li>There are three alternative strategic functions: </li></ul><ul><ul><li>Static strategy maintains a static portfolio mix </li></ul></ul><ul><ul><li>Reactive strategy involves decisions based on events that have already occurred </li></ul></ul><ul><ul><li>Anticipatory strategy involves shifting funds before the markets move </li></ul></ul>
  34. 34. How TAA Can Benefit a Portfolio <ul><li>The goal of an anticipatory strategy is to outperform the portfolio without TAA </li></ul><ul><ul><li>The potential gains to a clairvoyant manager from TAA are enormous (see next slide) </li></ul></ul><ul><li>The portfolio manager must assess return within a risk/return framework </li></ul>
  35. 35. How TAA Can Benefit a Portfolio (cont’d) Source: Ensign Peak Advisors, Inc., Salt Lake City, UT 84150.
  36. 36. Designing a TAA Program <ul><li>Before implementing a TAA program, a fund manager must establish: </li></ul><ul><ul><li>The normal mix </li></ul></ul><ul><ul><ul><li>The benchmark proportion each asset class constitutes in the portfolio </li></ul></ul></ul><ul><ul><li>The mix (exposure) range </li></ul></ul><ul><ul><ul><li>Specifies how much the current mix can deviate from the normal mix </li></ul></ul></ul>
  37. 37. Designing a TAA Program (cont’d) <ul><li>Before implementing a TAA program, a fund manager must establish (cont’d): </li></ul><ul><ul><li>The swing component </li></ul></ul><ul><ul><ul><li>The percentage of the total portfolio whose composition by asset class may change </li></ul></ul></ul><ul><ul><ul><li>The key element of TAA is properly investing the swing component </li></ul></ul></ul>
  38. 38. Efficient Market Implications <ul><li>TAA programs implicitly assume it is possible to outperform a buy-and-hold strategy by shifting asset classes </li></ul><ul><ul><li>Inconsistent with the efficient market hypothesis </li></ul></ul><ul><li>Some fund managers have good records with TAA programs </li></ul><ul><ul><li>Might be skill or luck </li></ul></ul>
  39. 39. Impact of Transaction Costs <ul><li>The portfolio incurs trading fees each time a trade occurs </li></ul><ul><li>If the marginal gains from TAA switching do not exceed transaction costs, the program is not effective </li></ul>
  40. 40. Costs of Revision <ul><li>Costs of revising a portfolio can: </li></ul><ul><ul><li>Be direct dollar costs </li></ul></ul><ul><ul><li>Result from the consumption of management time </li></ul></ul><ul><ul><li>Stem from tax liabilities </li></ul></ul><ul><ul><li>Result from unnecessary trading activity </li></ul></ul>
  41. 41. Commissions <ul><li>Investors pay commissions both to buy and to sell shares </li></ul><ul><li>Commissions at a brokerage firm may be a function of both: </li></ul><ul><ul><li>The dollar value of the trade </li></ul></ul><ul><ul><li>The number of shares involved in the trade </li></ul></ul>
  42. 42. Commissions (cont’d) <ul><li>The commission on a trade is split between the broker and the firm for which the broker works </li></ul><ul><ul><li>Brokers with a high level of production keep a higher percentage than a new broker </li></ul></ul><ul><li>Some brokers discount their commissions with their more active clients </li></ul>
  43. 43. Commissions (cont’d) <ul><li>Discount brokerage firms : </li></ul><ul><ul><li>Offer substantially reduced commission rates </li></ul></ul><ul><ul><li>Offer few ancillary services, such as market research or periodic newsletters </li></ul></ul><ul><li>Retail commissions at a full-service firm average about 2 percent of the trade value </li></ul>
  44. 44. Transfer Taxes <ul><li>Transfer taxes are: </li></ul><ul><ul><li>Imposed by some states on the transfer of securities </li></ul></ul><ul><ul><li>Usually very modest </li></ul></ul><ul><ul><li>Not normally a material consideration in the portfolio management process </li></ul></ul>
  45. 45. Market Impact <ul><li>The market impact of placing the trade is the change in market price purely because of executing the trade </li></ul><ul><li>Market impact is a real cost of trading </li></ul><ul><li>Market impact is especially pronounced for shares with modest daily trading volume </li></ul>
  46. 46. Management Time <ul><li>Most portfolio managers handle more than one account </li></ul><ul><li>Rebalancing several dozen portfolios is time consuming </li></ul>
  47. 47. Tax Implications <ul><li>Individual investors and corporate clients must pay taxes on the realized capital gains associated with the sale of a security </li></ul><ul><li>Tax implications are usually not a concern for tax-exempt organizations </li></ul>
  48. 48. Window Dressing <ul><li>Window dressing refers to cosmetic changes made to a portfolio near the end of a reporting period </li></ul><ul><li>Portfolio managers may sell losing stocks at the end of the period to avoid showing them on their fund balance sheets </li></ul>
  49. 49. Rising Importance of Trading Fees <ul><li>Flippancy regarding commission costs is unethical and sometimes illegal </li></ul><ul><li>Trading fees are receiving increased attention because of: </li></ul><ul><ul><li>Investment banking scandals </li></ul></ul><ul><ul><li>Lawsuits regarding churning </li></ul></ul><ul><ul><li>Incomplete prospectus information </li></ul></ul>
  50. 50. Contributions to the Portfolio <ul><li>Periodic additional contributions to the portfolio from internal or external sources must be invested </li></ul><ul><li>If an account holds its securities in a street name, dividends go to the brokerage firm holding the securities on the client’s behalf </li></ul><ul><li>If the portfolio manager receives the dividend checks, there needs to be some temporary haven for these funds until they accumulate sufficiently to finance the purchase of more securities or until they are paid as income to the fund beneficiary </li></ul>
  51. 51. When Do You Sell Stock? <ul><li>Knowing when to sell a stock is a very difficult part of investing </li></ul><ul><li>Behavioral evidence suggests the typical investor sells winners too soon and keeps losers too long </li></ul>
  52. 52. Rebalancing <ul><li>Rebalancing can cause the portfolio manager to sell shares even if they are not doing poorly </li></ul><ul><li>Profit taking with winners is a logical consequence of portfolio rebalancing </li></ul>
  53. 53. Upgrading <ul><li>Investors should sell shares when their investment potential has deteriorated to the extent that they no longer merit a place in the portfolio </li></ul><ul><li>It is difficult to take a loss, but it is worse to let the losses grow </li></ul>
  54. 54. Sale of a Stock Via Stop Orders <ul><li>Stop orders : </li></ul><ul><ul><li>Are usually used to sell but can be used to buy </li></ul></ul><ul><ul><li>A sell stop becomes a market order to sell a set number of shares if shares trade at the stop price </li></ul></ul><ul><ul><li>Can be used to minimize losses or to protect a profit </li></ul></ul>
  55. 55. Using Stops to Minimize Losses <ul><li>Stop-loss orders can be used to minimize losses </li></ul><ul><ul><li>e.g., you bought a share for $23 and want to sell it if it falls below $18 </li></ul></ul><ul><ul><ul><li>Place a stop-loss order at $18 </li></ul></ul></ul>
  56. 56. Using Stops to Protect Profits <ul><li>Stop orders can be used to protect profits </li></ul><ul><ul><li>e.g., a stock you bought for $33 now trades for $48 and you want to protect the profits at $45 </li></ul></ul><ul><ul><ul><li>If the stock retreats to $45, you lock in the profit if you place a stop order </li></ul></ul></ul><ul><ul><ul><li>If the stock continues to increase, you can use a crawling stop to increase the stop price </li></ul></ul></ul>
  57. 57. Change in Client Objectives <ul><li>The client’s investment objectives may change occasionally: </li></ul><ul><ul><li>e.g., a church needs to generate funds for a renovation and changes the objective for the endowment fund from growth of income to income </li></ul></ul><ul><ul><ul><li>Reduce the equity component of the portfolio </li></ul></ul></ul>
  58. 58. Change in Market Conditions <ul><li>Many fund managers seek to actively time the market </li></ul><ul><li>When a portfolio manager’s outlook becomes bearish, he may reduce his equity holdings </li></ul>
  59. 59. Buy-Outs <ul><li>A firm may be making a tender offer for one of the portfolio holdings </li></ul><ul><ul><li>i.e., another firm wants to acquire the security position </li></ul></ul><ul><li>It is generally in the client’s best interest to sell the stock to the potential acquirer </li></ul>
  60. 60. Caprice <ul><li>Portfolio managers: </li></ul><ul><ul><li>Should be careful about making unnecessary trades </li></ul></ul><ul><ul><li>Must pay attention to their experience, intuition, and professional judgment </li></ul></ul><ul><li>An experienced portfolio manager worried about a particular holding should probably make a change </li></ul>
  61. 61. Final Thoughts <ul><li>Hindsight is an inappropriate perspective for investment decision making </li></ul><ul><ul><li>Everything you do as a portfolio manager must be logically justifiable at the time you do it </li></ul></ul><ul><li>Portfolio managers are torn between a desire to protect profits or minimize further losses and the potential for price appreciation </li></ul>

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