Equity Portfolio Management
LOS. 24p - Enhanced Indexing
In a derivatives-based enhanced indexing strategy, the manager obtains an equity exposure through derivatives. A common method of doing so is to equitize cash. Here the manager holds a cash position and a long position in an equity futures contract. The manager can then attempt to generate an excess return by altering the duration of the cash position. If the yield curve is upward sloping, the manager invests longer-term, if she thinks the higher yield is worth it. If, on the other hand, the yield curve is flat, the manager invests in short-duration, fixed-income securities because there would be no reward for investing on the long end. In these derivative-based strategies, the value added (alpha) is coming from the non-equity portion of the portfolio and the equity exposure is coming through derivatives. Q1: How to match the cash position and long position in an equity futures contract?
Q2: How to alter the duration of the cash position? Does’t cash position mean duration less than 1 year? Thanks.
I’m not quite sure what you mean by “matching” the cash position and the equity futures position, but I’ll give it a shot: if you have, say, $100 million in cash and you want a portfolio that is 40% fixed income and 60% equity, then you need a long position in $150 million of equity futures contracts.
You alter the duration of cash with bond futures. And, yes, cash generally has a duration of less than 1 year. If they don’t give you the duration of cash, you should assume that it is zero years, but often they’ll give you something such as 0.25 years.
I wrote an article on adjusting the duration of a fixed income portfolio: http://financialexamhelp123.com/adjusting-the-valueduration-of-a-fixed-income-portfolio-using-bond-futures/
Cool, many thanks!
Sorry not fully understood why $100 million in cash and you want a portfolio that is 40% fixed income and 60% equity, then you need a long position in $150 million of equity futures contracts?
Could you elaborate it more? Many thanks!
If you have $100 million in cash and that’s supposed to be 40% of your portfolio, then your portfolio in total has to be $100 million ÷ 40% = $250 million. The remaining $150 million (60% of $250 million) is equity.
As I said, I wasn’t sure what you meant by “matching”, so what I wrote there may not address your concern at all. If you can elaborate on what you meant, I might be able to do a better job.