Book 4 R29 BB7 part 2

CFA Level III Portfolio Management
#1

can someone help me understand why we divide the 1.5 million by 0.15%?

Andrew Isaac runs a $100 million diversified equity portfolio (about 200 positions) using the the Russell 1000 as his investable universe. The total capitalization of the index is approximately $20 trillion. Isaac’s strategy is very much size agnostic. He consistently owns securities along the entire size spectrum of permissible securities. The strategy was designed with the following constraints:

No investment in any security whose index weight is less than 0.015% (approximately 15% of the securities in the index)

Maximum position size equal to the lesser of 10× the index weight or the index weight plus 150 bps

No position size that represents more than 5% of the security’s average daily trading volume (ADV) over the trailing three months

The smaller securities in Isaac’s permissible universe trade about 1% of shares outstanding daily. At what level of AUM is Isaac’s strategy likely to be affected by the liquidity and concentration constraints?

Based on the index capitalization of $20 trillion, the size constraint indicates that the smallest stocks in his portfolio will have a minimum market cap of about $3 billion (0.015% × $20 trillion). The ADV of the stocks at the lower end of his capitalization constraint would be about $30 million (1% × $3 billion). Because Isaac does not want to represent more than 5% of any security’s ADV, the maximum position size for these smaller-cap stocks is about $1.5 million (5% × $30 million). It appears that Isaac’s strategy will not be constrained until the portfolio reaches about $1 billion in size ($1.5 million ÷ 0.15% = $1 billion). If the level of AUM exceeds $1 billion, his position size constraints will require the portfolio to hold a larger number of smaller-cap positions. There is room to grow this strategy.

#2

The final step in determining liquidity and concentration constraints is to assess will the same strategy can be adopted or not in case asset position increase. Hence, you divide by the maximum position size that is stated in the case. The maximum position is equal to the lesser of 10× the index weight or the index weight plus 150 bps as stated in the case.

Hence the maximum position is 10 multiplied by the index weight which will be equal to (1.5MM/100MM)=0.015*10, which would give you the 0.15%.

1 Like
#3

Oh thank you. I read the question several times but somehow didn’t see that point…

#4

Thanks for this. I get confused when you calculate the index weight (1.5MM/100MM). The 100MM is the size of his portfolio not the index–the index is $20 trillion. So i just don’t follow this calc. Any insights would be appreciated.

#5

It’s more than a year later, but I was wondering this same thing.
I think it goes down to the fact that they are describing the constraints in terms of the benchmark index in the text, so you need to calculate the constraints in terms of the benchmark not your individual portfolio. In addition, the question is asking you for what level of AUM will it be a concern, the 100M is your current AUM and they want you to find the level of AUM, so the AUM is the variable you are actually trying to solve for, so you are not going to use your current level, it’s negligible.

#6

It appears that the author of that question felt compelled to make the reasoning in the answer as convoluted as possible. It should be a straightforward calculation.