The factor-mimicking portfolio in the test is dollar neutral and free to
short. The book a mandate will hold usually is not. A long-only
constraint replaces a negative active weight with a floor at minus the
benchmark weight, and the names the researcher most wants to underweight
are often the names whose benchmark weight is already a few basis
points. The constraint mathematics and the tactical factor limits are already written. This note records
what those constraints do to a characteristic portfolio, using the
concentration facts Qian report for the S&P 500.
Learning objectives. By the end of this note you should be able to:
- write the long-only rule as and explain why a negative forecast on a small benchmark name cannot be expressed;
- contrast an unconstrained long-short book, a 125/25 constrained long-short book, and a long-only book;
- state how a size-neutral long-only mandate pushes active risk into the largest names;
- keep a single-name cap and a sector bound distinct from factor neutrality.
In this lesson
- The mandate changes the mimicking portfolio
- Caps that are not factor neutrality
Before you start
- Turnover and capacity
- Portfolio Constraints
- Factor Risk Management: Tactical Limits, Strategic Constraints, and Systematic Hedging
The full lesson, with worked examples and exercise solutions, is for members.
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