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CFA® Level III · Portfolio Construction · free lesson
Overview of Equity Portfolio Management
Equities are the growth engine of most portfolios, but how they are owned matters as much as how much is owned. This module explains the roles equities play and how managers segment the universe, adds up the income and costs that separate gross from net returns, weighs the benefits and costs of shareholder engagement, and shows how to choose between passive and active approaches and select a benchmark that fairly measures a manager.
What you will learn
1. Explain the roles equities can play in a client's portfolio and compare ways of segmenting the equity universe by size and style, geography and economic activity.
- Roles of equities: capital appreciation, dividend income, diversification, long-run inflation hedging and client-specific aims such as ESG or religious values.
- Equities hedge inflation only over long horizons; an inflation shock usually lowers real equity returns in the short run.
- Size and style segmentation is easy to benchmark, but stocks migrate across style boxes as prices move.
- Geographic segmentation (developed, emerging, frontier) ignores where multinationals actually earn their revenue.
- Sector classification (GICS, ICB) captures business-cycle exposure but fits conglomerates poorly and changes over time.
2. Identify the income and cost components of an equity portfolio, including securities lending, and estimate their effect on net performance.
- Income sources: dividends, securities lending fees and ancillary income such as option premiums.
- Securities lending is collateralised (about 102% to 105%); the lender receives manufactured dividends but cannot vote lent shares unless it recalls them.
- Lending risks: borrower default, collateral reinvestment losses and operational errors.
- Costs: management, administration, marketing/distribution, trading and the cost of the investment approach.
- Annual trading-cost drag is about turnover x 2 x one-way cost per trade.
3. Discuss the benefits and costs of shareholder engagement for companies and investors, and the role of an equity manager in engagement and proxy voting.
- Engagement benefits companies (insight into owners' views, better governance) and investors (information, influence on value, evidence of stewardship).
- Free-rider problem: the engaging investor bears the cost while all shareholders share the gain.
- Costs include staff time, exposure to inside information, conflicts of interest and the risk of short-term activism.
- Empty voting: holding votes, for example through borrowed shares, without a matching economic stake.
- Managers vote under a written policy, may use proxy advisers but stay responsible, and can escalate or engage collaboratively.
4. Compare the rationales for approaches along the passive-to-active spectrum, and select an appropriate equity benchmark given how index constituents, weighting and rebalancing affect its behaviour.
- Move toward active only where the segment is inefficient, skill can be identified in advance and costs are justified.
- Client exclusions, tax needs and tracking-error limits can be met with separately managed or customized index portfolios.
- A benchmark must be representative, investable, transparent and specified in advance.
- Cap weighting: low turnover but large-cap and momentum tilts; price weighting: driven by share price; equal weighting: small-cap tilt and frequent rebalancing; fundamental weighting: value tilt.
- Reconstitution and rebalancing rules drive the turnover and trading costs of tracking an index.
Module at a glance
- Equities provide capital appreciation, dividend income and diversification, but hedge inflation only over long horizons.
- Segment the universe by size and style, geography or economic activity; each method has blind spots.
- Net return = gross return + securities lending and other income - management, administration, distribution and trading costs.
- Trading-cost drag is about turnover x 2 x one-way cost; costs are certain while alpha is not.
- Engagement creates value for all shareholders, but the free-rider problem leads diversified managers to under-invest in it.
- Lent shares cannot be voted unless recalled, and borrowed shares can create empty votes.
- Choose passive or active by the segment's efficiency, evidence of skill, client constraints and costs; pick a benchmark that matches the manager's universe and understand its weighting scheme.
This free module has 4 lessons, 16 practice questions with full explanations and 1 essay case with a model answer.