CHAPTER 6
An Architecture for Equity Portfolio Management
Principal
Jacobs Levy Equity Management
Kenneth N. Levy, CFA
Principal
Jacobs Levy Equity Management
Anyone who has ever built a house knows how important it is to start out with a sound architectural design. A sound design can help ensure that the end product will meet all the homeowner's expectations—material, aesthetic, and financial. A bad architectural design, or no design, offers no such assurance and is likely to lead to poor decision making, unintended results, and cost overruns.
It is equally important in building an equity portfolio to start out with some framework that relates the raw materials—stocks—and the basic construction techniques—investment approaches—to the end product. An architecture of equity management that outlines the basic relationships between the raw investment material, investment approaches, potential rewards, and possible risks can provide a blueprint for investment decision making.
We provide such a blueprint in this chapter. A quick tour of this blueprint reveals the following building blocks—an all-encompassing core comprising the whole investable universe (whether international or domestic) and its constituent style subsets of large-cap growth, large-cap value, and small-cap stocks. Investment approaches can also be roughly categorized into the following groups—passive, engineered (quantitative) active, or traditional active, with risk generally increasing as one moves from passive to traditional. These basic approaches may be extended by various means, including dynamic trading across market subsets or combining long positions with some degree of short selling. Understanding the market's building blocks and the advantages and disadvantages of each investment approach can improve overall investment results.