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Equity Valuation and Portfolio Management by Harry M. Markowitz, Frank J. Fabozzi

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ENGINEERED MANAGEMENT

Engineered management, based on quantitative techniques and methods, recognizes that markets are reasonably efficient in digesting information and that stock price movements in response to unanticipated news are largely random. It also recognizes, however, that significant, measurable pricing inefficiencies do exist, and it seeks to deliver incremental returns by modeling and exploiting these inefficiencies. In this endeavor, it applies to the same company fundamental and economic data used by traditional active management many of the tools that fostered the development of passive management, including modern computing power, finance theory, and statistical techniques, instruments that can extend the reaches (and discipline the vagaries) of the human mind.

Engineered approaches use quantitative methods to select stocks and construct portfolios that will have risk-return profiles similar to those of underlying equity benchmarks but offer incremental returns relative to those benchmarks, at appropriate incremental risk levels. The quantitative methods used may range from fairly straightforward to immensely intricate. In selecting stocks, for example, an engineered approach may use something as simple as a dividend discount model, or it may employ complex multivariate models that aim to capture the complexities of the equity market.

The engineered selection process can deal with and benefit from as wide a selection universe as passive management. It can thus ...

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