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date: 16 February 2020

Abstract and Keywords

The article gives an overview of the current state of equity portfolio capacity analysis. The investment performance exhibits two factors that include the underlying investment strategy of the portfolio manager and the execution costs incurred in realizing those objectives. Liquidity, measured in terms of implementation costs, can be affected by changing the breadth of the portfolio or by changing the investable universe. The liquidity effects differ depending on the investment strategy, implying that capacity is a strategy-specific phenomenon. The cost-aware portfolio performs much better, yielding a modest but positive Sharpe ratio of 0.07. The average costs of implementing the cost-aware rebalancing strategy are two to four times lower than the costs of implementing the non-cost-aware strategy. Portfolio net returns are used as the yardstick by which the alternative combinations of turnover levels and fund sizes are compared. Expected costs are derived from ITG's Agency Cost Estimator. The generation of these costs relies on a transparent methodology, and permits stock-specific estimates, which can be matched against expected returns. The covariance estimates are provided by the monthly US model from the suite of ITG risk models. The model is estimated using time-series on a per-stock basis. The factor covariance matrix is scaled using an option-implied adjustment coefficient to provide forward-looking risk forecasts.

Keywords: equity portfolio capacity, transaction costs, ITG's Agency Cost Estimator, time-series, portfolio net returns

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