Dynamic Exposure Targetingm J. Portfolio Management, Summer 2012

Abstract

Achieving desired exposures to information sources is critical to successful active investing. A portfolio manager, for example, wants to increase her portfolio’s exposure to a signal — how long will it take? By how much should she change the signal’s weight? How will exposures to other signals change? If she turns off a signal, for how long will the exposure to it persist? Can she accelerate these shifts? These challenges can present themselves whenever markets or business conditions change. Rule-of-thumb answers can mislead, as exposures are affected—not only by the sequence of weight changes — but also by signal speeds and correlations, and by the levels of risk and turnover. This paper solves for the combined effects of portfolio and signal dynamics, derives explicit predictions of the resulting exposure dynamics, and provides the intuition behind these results. The solutions include cost control as well as expectations over all realizations of the signals, both current and prior. A simple but central result describes exposure shift speeds, and the paper shows that interactions between different features can lead to unexpected results. This work allows a portfolio manager to predict and manage the timing and extent of the portfolio’s exposure to its information sources.