Page iii Active Portfolio Management A Quantitative Approach for Providing Superior Returns and Controlling Risk Richard C. Grinold Ronald N. Kahn SECOND EDITION
Page vii CONTENTS Preface xi Acknowledgments xv Chapter 1 Introduction 1 Part One Foundations Chapter 2 Consensus Expected Returns: The Capital Asset Pricing Model 11 Chapter 3 Risk 41 Chapter 4 Exceptional Return, Benchmarks, and Value Added 87 Chapter 5 Residual Risk and Return: The Information Ratio 109 Chapter 6 The Fundamental Law of Active Management 147 Part Two Expected Returns and Valuation Chapter 7 Expected Returns and the Arbitrage Pricing Theory 173
Page viii Chapter 8 Valuation in Theory 199 Chapter 9 Valuation in Practice 225 Part Three Information Processing Chapter 10 Forecasting Basics 261 Chapter 11 Advanced Forecasting 295 Chapter 12 Information Analysis 315 Chapter 13 The Information Horizon 347 Part Four Implementation Chapter 14 Portfolio Construction 377 Chapter 15 Long/Short Investing 419 Chapter 16 Transactions Costs, Turnover, and Trading 445 Chapter 17 Performance Analysis 477
Page ix Chapter 18 Asset Allocation 517 Chapter 19 Benchmark Timing 541 Chapter 20 The Historical Record for Active Management 559 Chapter 21 Open Questions 573 Chapter 22 Summary 577 Appendix A Standard Notation 581 Appendix B Glossary 583 Appendix C Return and Statistics Basics 587 Index 591
Page xi PREFACE Why a second edition? Why take time from busy lives? Why devote the energy to improving an existing text rather than writing an entirely new one? Why toy with success? The short answer is: our readers. We have been extremely gratified by Active Portfolio Management's reception in the investment community. The book seems to be on the shelf of every practicing or aspiring quantitatively oriented investment manager, and the shelves of many fundamental portfolio managers as well. But while our readers have clearly valued the book, they have also challenged us to improve it. Cover more topics of relevance to today. Add empirical evidence where appropriate. Clarify some discussions. The long answer is that we have tried to improve Active Portfolio Management along exactly these dimensions. First, we have added significant amounts of new material in the second edition. New chapters cover Advanced Forecasting (Chap. 11), The Information Horizon (Chap. 13), Long/Short Investing (Chap. 15), Asset Allocation (Chap. 18), The Historical Record for Active Management (Chap. 20), and Open Questions (Chap. 21). Some previously existing chapters also cover new material. This includes a more detailed discussion of risk (Chap. 3), dispersion (Chap. 14), market impact (Chap. 16), and academic proposals for performance analysis (Chap. 17). Second, we receive exhortations to add more empirical evidence, where appropriate. At the most general level: how do we know this entire methodology works? Chapter 20, on The Historical Record for Active Management, provides some answers. We have also added empirical evidence about the accuracy of risk models, in Chap. 3. At the more detailed level, readers have wanted more information on typical numbers for information ratios and active risk. Chapter 5 now includes empirical distributions of these statistics.