Portfolio Management in Practice, Volume 3

Equity Portfolio Management

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• Publisher: Wiley
• Year: 2020
• ISBN:
  9781119789260
• Edition: 1
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

Discover the latest essential resource on equity portfolio management for students and investment professionals.

Part of the CFA Institute's three-volume Portfolio Management in Practice series, Equity Portfolio Management offers a fuller treatment of active versus passive equity investment strategies. This text outlines key topics in the portfolio management process with clear, concise language to serve as an accessible guide for students and current industry professionals.

Building on content in the Investment Management and Equity Valuation volumes in the CFA Institute Investment Series, Equity Portfolio Management provides an in-depth, technical examination of constructing and evaluating active equity methods.

This volume explores:

• An overview of passive versus active equity strategies
• Market efficiency underpinnings of passive equity strategies
• Active equity strategies and developing portfolios to reflect active strategies
• Technical analysis as an additional consideration in executing active equity strategies

To further enhance your understanding of the tools and techniques covered here, don't forget to pick up the Portfolio Management in Practice, Volume 3: Equity Portfolio Management Workbook. The workbook is the perfect companion resource containing Learning Outcomes, Summary Overview sections, and challenging practice questions that align chapter-by-chapter with the main text.

Equity Portfolio Management alongside the other Portfolio Management in Practice volumesdistill the knowledge, skills, and abilities readers need to succeed in today's fast-paced financial world.

CHAPTER 1
OVERVIEW OF EQUITY SECURITIES

Ryan C. Fuhrmann CFA

Asjeet S. Lamba PhD, CFA

LEARNING OUTCOMES

The candidate should be able to:

• describe characteristics of types of equity securities;
• describe differences in voting rights and other ownership characteristics among different equity classes;
• distinguish between public and private equity securities;
• describe methods for investing in non-domestic equity securities;
• compare the risk and return characteristics of different types of equity securities;
• explain the role of equity securities in the financing of a company’s assets;
• distinguish between the market value and book value of equity securities;
• compare a company’s cost of equity, its (accounting) return on equity, and investors’ required rates of return.

1. INTRODUCTION

Equity securities represent ownership claims on a company’s net assets. As an asset class, equity plays a fundamental role in investment analysis and portfolio management because it represents a significant portion of many individual and institutional investment portfolios.

The study of equity securities is important for many reasons. First, the decision on how much of a client’s portfolio to allocate to equities affects the risk and return characteristics of the entire portfolio. Second, different types of equity securities have different ownership claims on a company’s net assets, which affect their risk and return characteristics in different ways. Finally, variations in the features of equity securities are reflected in their market prices, so it is important to understand the valuation implications of these features.

This chapter provides an overview of equity securities and their different features and establishes the background required to analyze and value equity securities in a global context. It addresses the following questions:

• What distinguishes common shares from preference shares, and what purposes do these securities serve in financing a company’s operations?
• What are convertible preference shares, and why are they often used to raise equity for unseasoned or highly risky companies?
• What are private equity securities, and how do they differ from public equity securities?
• What are depository receipts and their various types, and what is the rationale for investing in them?
• What are the risk factors involved in investing in equity securities?
• How do equity securities create company value?
• What is the relationship between a company’s cost of equity, its return on equity, and investors’ required rate of return?

The remainder of this chapter is organized as follows. Section 2 provides an overview of global equity markets and their historical performance. Section 3 examines the different types and characteristics of equity securities, and Section 4 outlines the differences between public and private equity securities. Section 5 provides an overview of the various types of equity securities listed and traded in global markets. Section 6 discusses the risk and return characteristics of equity securities. Section 7 examines the role of equity securities in creating company value and the relationship between a company’s cost of equity, its return on equity, and investors’ required rate of return. The final section summarizes the chapter.

2. EQUITY SECURITIES IN GLOBAL FINANCIAL MARKETS

This section highlights the relative importance and performance of equity securities as an asset class. We examine the total market capitalization and trading volume of global equity markets and the prevalence of equity ownership across various geographic regions. We also examine historical returns on equities and compare them to the returns on government bonds and bills.

Exhibit 1 summarizes the contributions of selected countries and geographic regions to global gross domestic product (GDP) and global equity market capitalization. Analysts may examine the relationship between equity market capitalization and GDP as a rough indicator of whether the global equity market (or a specific country’s or region’s equity market) is under, over, or fairly valued, particularly compared to its long-run average.

Exhibit 1 illustrates the significant value that investors attach to publicly traded equities relative to the sum of goods and services produced globally every year. It shows the continued significance, and the potential over-representation, of US equity markets relative to their contribution to global GDP. That is, while US equity markets contribute around 51 percent to the total capitalization of global equity markets, their contribution to the global GDP is only around 25 percent. Following the stock market turmoil in 2008, however, the market capitalization to GDP ratio of the United States fell to 59 percent, which is significantly lower than its long-run average of 79 percent.

As equity markets outside the United States develop and become increasingly global, their total capitalization levels are expected to grow closer to their respective world GDP contributions. Therefore, it is important to understand and analyze equity securities from a global perspective.

EXHIBIT 1 Country and Regional Contributions to Global GDP and Equity Market Capitalization (2017)

Sources: The WorldBank Databank (2017), and Dimson, Marsh, and Staunton (2018).

Exhibit 2 lists the top 10 equity markets at the end of 2017 based on total market capitalization (in billions of US dollars), trading volume, and the number of listed companies.¹ Note that the rankings differ based on the criteria used. For example, the top three markets based on total market capitalization are the NYSE Euronext (US), NASDAQ OMX, and the Japan Exchange Group; however, the top three markets based on total US dollar trading volume are the Nasdaq OMX, NYSE Euronext (US), and the Shenzhen Stock Exchange, respectively.²

EXHIBIT 2 Equity Markets Ranked by Total Market Capitalization at the End of 2017 (Billions of US Dollars)

Rank	Name of Market	Total US Dollar Market Capitalization	Total US Dollar Trading Volume	Number of Listed Companies
1	NYSE Euronext (US)	$22,081.4	$16,140.1	2,286
2	NASDAQ OMX	$10,039.4	$33,407.1	2,949
3	Japan Excha...

Table of contents

• Cover
• Title Page
• Copyright
• Contents
• PREFACE
• ACKNOWLEDGMENTS
• ABOUT THE CFA INSTITUTE INVESTMENT SERIES
• CHAPTER 1 OVERVIEW OF EQUITY SECURITIES
• CHAPTER 2 MARKET EFFICIENCY
• CHAPTER 3 OVERVIEW OF EQUITY PORTFOLIO MANAGEMENT
• CHAPTER 4 PASSIVE EQUITY INVESTING
• CHAPTER 5 ANALYSIS OF ACTIVE PORTFOLIO MANAGEMENT
• CHAPTER 6 ACTIVE EQUITY INVESTING: STRATEGIES
• CHAPTER 7 ACTIVE EQUITY INVESTING: PORTFOLIO CONSTRUCTION
• CHAPTER 8 TECHNICAL ANALYSIS
• GLOSSARY
• ABOUT THE AUTHORS
• ABOUT THE CFA PROGRAM
• INDEX
• END USER LICENSE AGREEMENT