Equity Portfolio Strategies

Section: Equity Portfolio Strategies Estimated study time: 45 minutes Content: Equity portfolio management at Level 3 focuses on the full investment management process: translating an investment mandate into a portfolio, managing risk at the total portfolio level, and evaluating performance versus a benchmark. Equity strategies span a spectrum from fully passive (index replication) to fully active (high-conviction stock selection), with many intermediate approaches in between. Passive equity management seeks to replicate the returns of a specified benchmark index. Full replication holds every security in the index in exact index proportions — eliminates tracking error but is costly for broad indices with thousands of holdings. Stratified sampling holds a representative subset of securities organized into cells that mirror the index's key characteristics (sector, market cap, country, style). Optimization-based replication uses factor models to construct a portfolio that minimizes expected tracking error without holding every security. Tracking error (the standard deviation of the difference between portfolio and benchmark returns) is the primary risk metric for passive strategies — lower is better, subject to cost constraints. Active equity management seeks to generate alpha — returns in excess of the benchmark on a risk-adjusted basis. Active risk (tracking error) quantifies how much the portfolio deviates from the benchmark. The Information Ratio (IR = alpha / active risk) is the primary performance measure for active managers. Fundamental active management is driven by bottom-up stock analysis — estimating intrinsic value and selecting mispriced securities. Systematic (quantitative) active management uses rules-based signals — value, quality, momentum, low volatility — applied across large universes. Factor-tilted portfolios occupy the middle ground: systematic factor exposures implemented at low cost. Long-short equity strategies allow portfolio managers to short overvalued securities…