Origins of Gains and Exposure to Risk in Passive Equity Portfolios

Attribution Analysis

Attribution analysis is covered in further detail in other sections of the curriculum. Since it pertains to explaining sources of risk and return, attribution analysis is a method of decomposing the investments in a portfolio. Besides, it maps out the factors responsible for risk and return.

Securities Lending

Larger portfolios can earn an extra return (typically 1-3% annually) by lending batches of securities to other investors. These borrowers use the securities for specific purposes and return them later. This adds to the returns of an equity portfolio, going beyond the usual income and capital appreciation. Securities lending can also help offset management fees.

Investor Activism

Passive investors aim to mirror an index's performance by holding the same securities in their portfolio. This means they must retain these holdings even if the company's management decisions are unfavorable. Selling off shares contradicts passive investing principles. However, a certain level of shareholder activism can let investors remain passive while also influencing company improvements. For instance, voting on shareholder proxies can enhance corporate governance and potentially raise stock prices. Activist investors often engage in company earnings calls and other actions to foster a vibrant and competitive company. 

Question

Which of the following least likely represents a form of shareholder activism in line with passive equity investing?

1. Participating in earnings calls.
2. Voting on shareholder matters.
3. Using large stakeholder positions to influence management.

Solution

The correct answer is A.

Participating in earnings calls is generally a more active approach and does not align with passive equity investing. In passive investing, the focus is on tracking or replicating a benchmark index's performance, and investors typically do not get directly involved in company activities like earnings calls. Participating in earnings calls is more aligned with active investing, where investors actively seek information and engage with company management.

B is incorrect. Voting on shareholder matters is a form of shareholder activism that can be in line with passive equity investing. Passive investors often participate in shareholder voting on matters like board elections, executive compensation, and other corporate governance issues. While it's a form of activism, it's still considered passive because it doesn't involve actively influencing management decisions beyond the standard shareholder voting process.

C is incorrect. Using large stakeholder positions to influence management is a form of shareholder activism and can be aligned with passive equity investing. Passive investors can use their significant ownership stakes to advocate for changes in company policies or governance, but this is typically done in a more passive manner compared to activist investors who actively seek to change management or company strategies.

Reading 24: Passive Equity Investing

Los 24 (f) Explain sources of return and risk to a passively managed equity portfolio