Can somebody pls. confim my understanding. S2000, can you please look into this when you have time.? Thanks.
Based on the below table, is the portfolio manager correct in saying that his portfolio has tilt towards large cap stocks with lower P/E & leverage
Portolio Benchmark Active Exposure
P/E -0.25 -0.35 0.10
Leverage -0.60 -0.40 -0.20
Market Cap 0.5 0.35 0.15
Is it correct to say that since the active exposure of portfolio to P/E is positive (0.10), the manager is not right when he is says they have tilt towards lower PE, since the Portfolio has above average sensitivity to P/E meaning higher P/E will influence the portfolio more than it would for the benchmark.
However, a positive active exposure for market cap implies, above average sensitivity to market cap that is is line with what the manager claims.
So if you want to have a tilt towards a particular factor, you need positive active exposure and coversely if you need want to move away from that particular factor, you need negative active exposure
dont wanna lose track of this problem…kindly comment
I believe your understanding is right.
Thanks for this. Been searching everywhere for some insight.
But, I don’t think this makes sense. Your statement “So if you want to have a tilt towards a particular factor, you need positive active exposure and coversely if you need want to move away from that particular factor, you need negative active exposure” would contradict what we see with LEVERAGE. If what you’re saying is true, and portfolio has a tilt for lower leverage, then it would have a POSITIVE active exposure as well, which in this case we see is not (-.2).
Perhaps, it would be more accurate to say that if you want a tilt relative to a benchmark for a factor, you will want POSITIVE factor sensitivity for a factor you want “more of.” For example, in this case you want HIGHER market cap companies, so you tilt your portfolio relative to benchmark for that, and thus your factor sensitivity is POSITIVE versus the benchmark sensitivity.
For P/E and Leverage, you want to tilt towards LOWER leverage and P/E ratios, so you want your factor sensitivty to be NEGATIVE versus the benchmark.
Can anyone confirm this? At this point, I can’t explain the logic behind it, just want someone to confirm so I can move onto the next problem in this mock (2013 morning).
Thanks.
JCho, I think you’ve got it. Think of it like quant, with the regression coefficients bj and what happens when you then forecast with it and plug stuff in. Same stuff going on here. And think of P/E not as just “P/E,” but think of it as what it is, the price of one dollar of earnings (per share). Leverage is the amount of Assets per one unit of Equity. Think about the numerator of A/E being the part of Leverage beta changing. It’s relative to the benchmark, and that benchmark is even capable of being viewed relative to the entire market.
You’re taking it a step further with the last statement, but you’re probably right… most people would want lower P/Es, and lower Leverage, for the most part. Maybe not a growth investor. And for low P/Es and Leverage to be “low,” somebody has to hold high P/E and/or Leverage.