Constraints on investment weights: What mandate authors in concentrated equity markets such as South Africa need to know

Abstract

ABSTRACTThis article demonstrates the importance of setting risk budgets and constraints mindful of the nature of the chosen benchmark and the investment environment. The asymmetrical inefficiency of the long-only constraint when applied to a concentrated investment environment such as the South African equities market is illustrated. We estimate the optimal distribution of investment weights in each security in the context of standard portfolio construction techniques and typical South African equity benchmarks and market conditions. These distributions provide guidance to mandate authors who are considering allowing limited shorting in their net long portfolios as to the amount of gearing that is likely to be required. These estimates also show authors of long-only mandates the circumstances and assets for which their restrictions are materially binding.