Hi all,
in the curriculum , they said that: “if the factor exposure is fully neutralized, the active risk will be entirely attributed to Active Share.”
I wonder whether “factor exposure fully neutralized” means that the factor exposure is the same as the factor exposure of benchmark index or factor exposure = 0 ?
Thank you
It means the concentration of the factors that are active in the portfolio are identical to the factor exposures of the benchmark. In such a portfolio you would essentially have no active risk (because your returns on the portfolio match the benchmark, and standard deviation of zero is well… zero? [ya, duh]). And if you have neutralized factor exposure you would expect there to be no excess return^^
so, In order to create active risk it implies the manager is taking active security selection bets on individual stocks in a portion of the portfolio that is not consistent to weights/factors of the benchmark - this is where active share is above zero all of a sudden. But the only source of that active risk is derived from the active share (where the portfolio differs from factor exposures of the benchmark).
did that make sense?
It means the folio is 0 beta. The risk is attributed to the wighting you assign to the security as against the weight of the sec in the benchmark. Eg - if you overweight a sec relative to benchmark and if that sec underperformed, you lose value and that’s additional risk which you attribute to active share.
I think you mean 1. If the portfolio was zero beta, it wouldn’t change value as the benchmark changes. Which means you WOULD have active risk. Since your portfolio return is 0.00% BUT THE BENCHMARK IS STILL GENERATING RETURN. and zero less 5% (for example) is -5% and all of a sudden you have a standard deviation that is non-zero.
Young padawans, time to listen.
The folio of 0 (not 1) beta is neutralized against the market risk factor (assuming you’re talking about market beta). However, it may be exposed to other factors such as volatility, momentum, size, etc. If it was exposured to beta of 1, it would be matching the index and there is no active share.
The definition of neutralize is to be nuetral. The best example of a neutrazation is the market-neutral hedge fund.
You have several options with factor exposures:
Thanks 125mph.
So far from your explanation, i understand that: Factor Neutralized means:
% weight exposure to factor A of your portfolio = % weight exposure to factor A of benchmark (beta of your portfolio = beta of the benchmark)
Correct me if i am wrong.
So what about the factor/stock diversified? i understand that your portfolio will expose to more factors and have more stocks. => it will have high active share but why low active risk?
Why the position of factor neutral and stock diversified on “Exhibit 7 illustrates how various combinations of factor exposure and idiosyncratic risk affect Active Share and active risk” in the text book is the same?
I guess I was wrong… and omg… CEO was closer to being right (for the first time 
).
To neutralize a factor means to match benchmark factor’s beta… So 0 is wrong, but technically it isn’t beta = 1 either (unless you’re going for a pure market beta of 1.)
I just came up on MM’s video on equity and he briefly mentioned it.
The factor exposure is fully neutralized if Bp - Bb = 0, and that would mean active risk is fully attributed to active share.
I take it, if your portfolio has matched all the betas (market, quality, size, value, momentum, etc), then the active risk is coming from active share.
time to revert to equities, perhaps ? again ?
If you aren’t investing in golden sacagawea coins then son, I have some bad news. . .