1 Active Portfolio Management¹

1.1 benchmark portfolio

1.2 exceptional returns relative to benchmark

1.3 trade off forecasts of exceptional return against additional risk

1.4 process of active management

1.4.1 processing of raw signals into exceptional return forecasts

1.4.2 portfolio construction, trading, performance analysis

1.4.3 asset selection, asset allocation, benchmark timing

1.5 forecasting

1.5.1 superior information

if your forecasts match the consensus, or your forecasts differe from the consensus but contain no information, this machinery will lead you back to the benchmark.

only as you develop superior information will your portfolio deviate from the benchmark.

1.6 success relies on breath and skill

1.7 mathematics cannot overcome ignorance, half-life

how to evaluating the horizon value of information.

1.8 where to look for superior information

1.8.1 forecasting factor returns

1.8.2 forecasting asset specific return

1.8.3 information sources that have proven valuable in the past

1.9 Applications

1.9.1 Structure model 1: Given Exposure, estimate factor returns

1.9.2 Structure model 2: Given Factor returns, estimate exposures.

1.9.3 Statistical Model 1: Principal Components Analysis

use the principal components to explain the other stocks, the historical return are already known, use this as the factors, then calculate the coefficients.

1.9.4 Statistical Model 2: Maximum Likeliood factor analysis

1.10 Valuation from cash flows

Risk-adjusted expectations:

the modern theory of valuation prices uncertain future cash flows by risk-adjusting the expected cash flows and discounting them to the present using the risk-free rate.

1.10.1 Valuation of equities

the standard quantitative method is the dividend discount model, which focuses on dividends, earnings, and growth.

Dividend discount model is only as good as their growth forecasts.

The goal of valuation is trying to find those equities which are mispriced and to make money when the price is corrected by the market.

1.11 Valuation in practice

stock value = financial value + operational value

2 Foundations

2.1 Consensus Expected Returns: The Capital Asset Pricing Model

2.2 Risk

2.3 Exceptional Return, Benchmarks, and Value Added

2.4 Residual Risk and Return: The Information Ratio

2.5 The Fundamental Law of Active Management

3 Expected Returns and Valuation

3.1 Expected Returns and the Arbitrage Pricing Theory

3.2 Valuation in Theory

3.3 Valuation in Practice

4 Information Processing

4.1 Forecasting Basics

4.2 Advanced Forecasting

4.3 Information Analysis

4.4 The Information Horizon

5 Implementation

5.1 Portfolio Construction

5.1.1 Quadratic Programming

5.1.2 SUMMARY

5.1.3 ALTERNATIVES TO MEAN/VARIANCE OPTIMIZATION

5.2 Long/Short Investing

5.3 Transactions Costs, Turnover, and Trading

5.4 Performance Analysis

5.5 Asset Allocation

5.6 Benchmark Timing

5.7 The Historical Record for Active Management

5.8 Open Questions

5.9 Summary

Footnotes:

Active+Portfolio+Management+Second+Edition, Richard Grinold and Ronald Kahn

Table of Contents

1 Active Portfolio Management1