Fin 2802 Investments Spring 2010 Dragon Tang Lecture

Overview • Treynor-Black model – Optimization using analysts’ forecasts of superior performance – Adjusting

Table 27. 1 Construction and Properties of the Optimal Risky Portfolio (properties 1 -5)

Table 27. 1 Construction and Properties of the Optimal Risky Portfolio (properties 6 -11)

Table 27. 2 Stock Prices and Analysts’ Target Prices for June 1, 2006 FIN

Figure 27. 1 Rates of Return on the S&P 500 (GSPC) and the Six

Table 27. 3 The Optimal Risky Portfolio with the Analysts’ New Forecasts FIN 2802,

Table 27. 4 The Optimal Risk Portfolio with Constraint on the Active Portfolio (WA

Figure 27. 2 Reduced Efficiency when Benchmark Is Lowered FIN 2802, Spring 10 -

Table 27. 5 The Optimal Risky Portfolio with the Analysts’ New Forecasts (benchmark risk

Figure 27. 3 Histogram of the Alpha Forecast FIN 2802, Spring 10 - Tang

Figure 27. 4 Organizational Chart for Portfolio Management FIN 2802, Spring 10 - Tang

Steps in the Black-Litterman Model • Step 1: Estimate the covariance matrix from historical

Figure 27. 5 Sensitivity of Black Litterman Portfolio Performance to Confidence Level (view is

Figure 27. 6 Sensitivity of Black Litterman Portfolio Performance to Confidence Level (view is

Table 27. 6 M-Square for the Portfolio, Actual Forecasts FIN 2802, Spring 10 -

Table 27. 7 M-Square for the Simulated Portfolios FIN 2802, Spring 10 - Tang

Concluding Remarks on the Theory of Active Investments • The gap between theory and

Summary • Treynor-Black model • Black-Litterman Model • Next Class: Performance Evaluation FIN 2802,

Slides: 19

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Fin 2802: Investments Spring, 2010 Dragon 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 • 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 27. 1 Construction and Properties of the Optimal Risky Portfolio (properties 1 -5) FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 3

Table 27. 1 Construction and Properties of the Optimal Risky Portfolio (properties 6 -11) FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 4

Table 27. 2 Stock Prices and Analysts’ Target Prices for June 1, 2006 FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 5

Figure 27. 1 Rates of Return on the S&P 500 (GSPC) and the Six Stocks June 2005 – May 2006 FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 6

Table 27. 3 The Optimal Risky Portfolio with the Analysts’ New Forecasts FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 7

Table 27. 4 The Optimal Risk Portfolio with Constraint on the Active Portfolio (WA < 1) FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 8

Figure 27. 2 Reduced Efficiency when Benchmark Is Lowered FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 9

Table 27. 5 The Optimal Risky Portfolio with the Analysts’ New Forecasts (benchmark risk constrained to 3. 85%) FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 10

Figure 27. 3 Histogram of the Alpha Forecast FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 11

Figure 27. 4 Organizational Chart for Portfolio Management FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 12

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 FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 13

Figure 27. 5 Sensitivity of Black Litterman Portfolio Performance to Confidence Level (view is correct) FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 14

Figure 27. 6 Sensitivity of Black Litterman Portfolio Performance to Confidence Level (view is false) FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 15

Table 27. 6 M-Square for the Portfolio, Actual Forecasts FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 16

Table 27. 7 M-Square for the Simulated Portfolios FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 17

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 FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 18

Summary • Treynor-Black model • Black-Litterman Model • Next Class: Performance Evaluation FIN 2802, Spring 10 - Tang Chapter 27: Practical Portfolio Management 19