Conditional Multifactor Models Research Articles

Performance and investment styles of international multi-asset funds during market crises

This paper presents a comprehensive investigation into the performance of multi-asset funds investing internationally. Based on a custom-built conditional multi-factor model, which includes several bond and equity-related factors, along with time-varying betas and alphas, we show that funds in our dataset significantly underperform from 2004 to 2021. This evidence holds even on a before-fee basis, with funds investing predominantly in bonds exhibiting significantly higher alphas than funds investing predominantly in equities. Since multi-asset funds may better hedge against market downturns than equity or bond funds, given their higher asset class diversification, we also evaluate performance for crisis and non-crisis phases separately. The results show that, during market crises, international multi-asset funds perform significantly better than in non-crisis times, achieving neutral performance. However, while funds that favour bond investments perform similarly across different market phases, funds that prioritize equity investments perform significantly better during crises. Consequently, multi-asset funds with higher bond holdings can be a better option during non-crisis periods, while funds with higher equity holdings should be preferred during market downturns. This somewhat puzzling finding seems to be related to funds’ cash holdings. By providing a better understanding of the asset allocation decisions of international mutual fund managers, as well as of their impact on fund performance, this work has meaningful implications for investors.

Robust market timing tests of Canadian hybrid mutual funds

PurposePrior research has documented inconclusive and/or mixed empirical evidence on the timing performance of hybrid funds. Their performance inferences generally do not efficiently control for fixed-income exposure, conditioning information, and cross-correlations in fund returns. This study examines the stock and bond timing performances of hybrid funds while controlling and accounting for these important issues. It also discusses the inferential implications of using alternative bootstrap resampling approaches.Design/methodology/approachWe examine the stock and bond timing performances of hybrid funds using (un)conditional multi-factor benchmark models with robust estimation inferences. We also rely on the block bootstrap method to account for cross-correlations in fund returns and to separate the effects of luck or sampling variation from manager skill.FindingsWe find that the timing performance of portfolios of funds is neutral and sensitive to controlling for fixed-income exposures and choice of the timing measurement model. The block-bootstrap analyses of funds in the tails of the distributions of stock timing performances suggest that sampling variation explains the underperformance of extreme left tail funds and confirms the good and bad luck in the bond timing management of tail funds. We report inference changes based on whether the Kosowski et al. or the Fama and French bootstrap approach is used.Originality/valueThis study provides extensive and robust evidence on the stock and bond timing performances of hybrid funds and their sensitivity based on (un)conditional linear multi-factor benchmark models. It examines the timing performances in the extreme tails funds using the block bootstrap method to efficiently identify (un)skilled fund managers. It also highlights the sensitivity of inferences to the choice of testing methodology.

Time-Varying Conditional Profitability of Momentum Strategies in Commodity Futures Market: Evidence from India

ABSTRACT Manuscript type: Research paper Research aim: This study aims to provide fresh evidence on the presence of momentum profitability in the Indian commodity futures market. Design/Methodology/Approach: This study is based on a sample of highly traded commodity future contracts of the Indian commodity market over the period from 2006 to 2017. It applies the conditional multi-factor model to test the time-varying performance of momentum strategies. Research findings: This study confirms the existence of exceptionally high abnormal momentum profitability in the commodity futures market despite the presence of transaction costs. However, the application of conditional multi-factor model suggests that momentum profits are basically time-varying. The low and insignificant correlation of momentum portfolios with stocks and bonds confirm that relative strength momentum portfolios of commodity futures can be effectively used to create a well-diversified portfolio. Theoretical contribution/Originality: This study analyses the time-varying conditional profitability of momentum strategies for the commodity market of emerging economies such as India. It enriches the small group of studies conducted on commodity futures in the Indian context. The major contribution of the study is the use of conditional multi-factor model to assess the possible role of time-varying conditional alpha and beta to define the momentum payoffs in commodity futures market for the Indian context. Policy implications: Policymakers should design more lucrative policies so as to attract the institutional investors for investment in the Indian commodity market. This is because domestic and foreign institutional investors are central to the enhancement and stability of the financial market. Research implications/Limitations: The study uses the 13 highly traded commodity futures contract to design the momentum strategies. The robustness of the high abnormal returns given by these strategies can be investigated further by the use of extended study period and expanded cross section of commodity futures contract.

Active trading strategies based on momentum and term structure signals in commodity futures market: evidence from India

This research designs an active double-sort strategy which integrates both momentum and term structure signals present in the commodity futures market. By using a sample of highly traded commodity future contracts of the Indian commodity market from 2006 to 2016, this study confirms the exceptionally high abnormal profitability of the double-sort strategy. The abnormal returns of the double-sort portfolios are robust to transaction costs incurred for designing these active strategies. The application of a conditional multi-factor model and sub-sample analysis suggests that the return profile of these strategies is basically time-varying. Moreover, the low and insignificant correlation of double-sort portfolios with stocks and bonds confirms that relative strength portfolios of commodity futures can be effectively used to create a well-diversified portfolio.

New Evidence on Conditional Factor Models

We estimate conditional multifactor models over a large cross section of stock returns matching 25 CAPM anomalies. Using conditioning information associated with different instruments improves the performance of the Hou, Xue, and Zhang (HXZ) (2015) and Fama and French (FF) (2015), (2016) models. The largest increase in performance holds for momentum, investment, and intangibles-based anomalies. Yet, there are significant differences in the performance of scaled models: HXZ clearly dominates FF in explaining momentum and profitability anomalies, while the converse holds for value–growth anomalies. Thus, the asset pricing implications of alternative investment and profitability factors (in a conditional setting) differ in a nontrivial way.

Real estate as a common risk factor in bank stock returns

Abstract This article investigates the potential role of real estate risk in the pricing of US bank stocks from February 1990 to December 2015. Generalized method of moments estimates of conditional multifactor models are provided. The real estate risk is proxied by the return of an investment strategy that is short on low-leverage real estate investment trust (REIT) assets and long on high-leverage REIT assets. We group banks into portfolios based on their market capitalization, real estate loans as a proportion of total assets, and book-to-market ratios. The results suggest that the real estate premium is a relevant risk factor in bank stocks returns. For instance, we find that a 100-basis-point increase to the real estate premium increases returns by 15.8 to 20.1 basis points for portfolios grouped by market capitalization. This conclusion remains when other oft-cited bank risk factors are considered, including small-minus-big, high-minus-low and the return on equity of the financial sector.

Securitized and Direct Real Estate Factors in the Pricing of US Bank Stocks

AbstractThis article analyzes the role of securitized and direct real estate risks in the pricing of US bank stocks. Real estate risk measures are drawn from the National Association of Real Estate Investment Trusts (NAREIT) and NCREIF indexes. Beside the real estate, the other risk exposures considered are the market, the term, and the default premiums. The period covered runs from February 1990 to December 2015. GMM estimates of conditional multifactor models report considerable evidence in favor of real estate risk in US bank stocks.

The performance of European SRI funds investing in bonds and their comparison to conventional funds

ABSTRACTThis paper evaluates the performance of European SRI fixed-income funds domiciled in France and in Germany compared to characteristics-matched conventional funds. Fund performance is evaluated by means of conditional multi-factor models that allow for both time-varying risk and performance. The results show that SRI balanced funds perform similarly to conventional funds, whereas SRI bond funds significantly outperform their peers. The outperformance of SRI bond funds seems more related to their government (and not their corporate) bond holdings. Compared to conventional funds, SRI funds are significantly less exposed to bonds issued by the countries most affected by the Euro sovereign debt crisis, which is consistent with more conservative and long term-oriented investment strategies.

The Performance of European Socially Responsible Fixed-Income Funds

Evidence to date on the performance of Socially Responsible Investments (SRI) has almost exclusively been conducted within equity markets. We provide new evidence on the potential of SRI for other asset classes, by assessing the performance of SRI fixed-income funds. This is the first comprehensive investigation on the performance of European SRI bond and balanced funds, domiciled in the main European markets (France, Germany and the UK), compared to characteristics-matched conventional funds.Our results, based on a conditional multi-factor model with time-varying alphas and betas, show that in most cases European SRI balanced funds exhibit no statistically significant differences in performance in relation to conventional funds, both during the overall sample period as well as during recession and expansion periods separately. With regard to SRI bond funds, empirical evidence is mixed. French SRI bond funds match the performance of their conventional peers, German funds slightly outperform and UK funds significantly underperform conventional funds. Furthermore, during expansion periods, funds from the Euro-Area countries significantly outperform their conventional peers, whereas during recessions they are able to perform at least as well as conventional funds. These results mean that SRI funds in the fixed-income area seem to provide additional protection to investors in market downturns.

New Evidence on Conditional Factor Models

We estimate conditional multifactor models over a large cross-section of stock returns associated with 25 alternative CAPM anomalies. Using conditioning information significantly improves the performance of the multifactor models of Hou, Xue, and Zhang (2015, HXZ) and Fama and French (2015, 2016). Both models have a similar global fit, yet HXZ clearly dominates other models in terms of pricing the extreme portfolio deciles and the cross-sectional dispersion in equity risk premia. Thus, the asset pricing implications of alternative investment and profitability factors differ significantly in the large cross-section of stocks. The HML factor is largely redundant when using conditioning information.

Conditional multifactor asset pricing model and market anomalies

Purpose – The purpose of this paper is to investigate the firm-specific anomaly effect and to identify market anomalies that account for the cross-sectional regularity in the Indian stock market. The paper also examines the cross-sectional return predictability of market anomalies after making the firm-specific raw return risk adjusted with respect to the systematic risk factors in the unconditional and conditional multifactor specifications. Design/methodology/approach – The paper employs first step time series regression approach to drive the risk-adjusted return of individual firms. For examining the predictability of firm characteristics on the risk-adjusted return, the panel data estimation technique has been used. Findings – There is a weak anomaly effect in the Indian stock market. The choice of a five-factor model (FFM) in its unconditional and conditional specifications is able to capture the book-to-market equity, liquidity and medium-term momentum effect. The size, market leverage and short-run momentum effect are found to be persistent in the Indian stock market even with the alternative conditional specifications of the FFM. The results also suggest that it is naï argue for disappearing size effect in the cross-sectional regularity. Research limitations/implications – Constrained upon the data availability, certain market anomalies and conditioning variables cannot be included in the analysis. Practical implications – Considering the practitioners' prospective, the results indicate that the profitable investment strategy with respect to the small size effect is still persistent and warrants close-ended mutual fund investment portfolio strategy for enhancing the long-term profitability. The short-run momentum effect can generate potential profits given a short-term investment horizon. Originality/value – This paper provides the first-ever empirical evidence from an emerging stock market towards the use of alternative conditional multifactor models for the complete explanation of market anomalies. In an attempt to analyze the anomaly effect in the Indian stock market, this paper provides further evidence towards the long-short hedge portfolio return variations in terms of a wide set of market anomalies that have been documented in prior literature.

Benchmark models of expected returns in U.K. portfolio performance: An empirical investigation

I use the second Hansen and Jagannathan (1997) distance measure (HJD) to examine whether index-based models similar to Cremers, Petajisto, and Zitzewitz (forthcoming) are more reliable benchmark models of expected returns than the Fama and French (1993) and Carhart (1997) models in U.K. stock returns. I use the second HJD as it is important to take account of pricing errors over possible contingent claims when considering benchmark models that are used in fund performance applications (Wang & Zhang, 2012). I find that all of the candidate benchmark models are misspecified. I find that conditional multifactor models provide significant lower second HJD compared to the unconditional factor models. I find that there is nothing to be gained in terms of significant lower second HJD in using the index-based models compared to the conditional Carhart model. My results suggest that among the models I consider, the most reliable models are the conditional Carhart model and the conditional seven-index model of Cremers et al. (forthcoming).

Mutual fund performance in Tunisia: A multivariate GARCH approach

This article investigates mutual fund performance in the Tunisian capital market using conditional multifactor models. In the mutual fund literature, the traditional approach to capture conditionality is the use of predetermined instruments. This study proposes a multivariate Generalized Autoregressive Conditional Heteroskedasticity (GARCH) approach to compute conditional measures. Overall, we find evidence of persistence in mutual fund performance only when we implement the multivariate GARCH method. This result is due to the fact that the Jensen alphas are estimated more precisely in the multivariate GARCH model than in the other approaches. These results indicate that the Tunisian capital market presents strong investment opportunities for sophisticated investors such as mutual funds.

Dynamic return predictability in the Russian stock market

This paper explores whether the relevance of a conditional multifactor model and autocorrelation in predicting the Russian aggregate stock return fluctuates over time. The source of return predictability is shown to vary considerably with information flow. In general, predictability of the Russian stock market return is at a high level. Autocorrelation increases during periods of low information flow. During periods of high information, conditional exposure to the local market risk and changes in oil price influence the expected return on the Russian stock market. The lagged global stock market factor and currency returns have insignificant influence.

On the Risk Exposure of Asia Pacific Banking Industry

Despite its potential benefits, financial globalization also carries some risks, especially for developing countries. The recent 1997 Asian financial crisis is such episode associated with a globalized financial system. In this paper, I examine whether there is any significant impact of the 1997 Asian crisis on the risk exposures of the banking sector for a group of Asia Pacific emerging markets. Using a conditional multi-factor asset-pricing model that allows time variation in the risk premiums, I find that the risk exposure increased during the crisis, with the greatest increase occurring for the crisis countries. However, the incremental increase in the risk exposure has diminished after the crisis. The evidence provided here indicates that the 1997 Asian crisis does not appear to have a permanent effect on the riskiness international banking industries, implying that the financial globalization is still beneficial, at least in the long run. Consequently, the main challenge for policy makers is to manage the integration process as to take full advantage of the opportunities, while minimizing its risks.

Fixed-income fund performance: Role of luck and ability in tail membership

The risk-adjusted performance (alphas) of a comprehensive and survivorship-free sample of Canadian bond funds after (before) management-related costs is negative (positive) and is weakly sensitive to the choice of the return-generating process. A conditional multi-factor model that captures maturity differences and default risk best describes the return-generating process of these funds. Examination of funds in the tails of the performance distribution using the block-bootstrap method suggests that “bad luck” causes the before costs underperformance of extreme left-tail funds and no fund possesses truly superior management skills.

An evaluation of conditional multi-factor models in active asset allocation strategies: an empirical study for the German stock market

This paper examines the out-of-sample performance of asset allocation strategies that use conditional multi-factor models to forecast expected returns and estimate the future variance and covariance. We find that strategies based on conditional multi-factor models outperform strategies based on unconditional multi-factor models, and do better than a passive buy-and-hold strategy. However, a strategy that uses the sample mean as a return forecast is superior. We also find that the estimation of the covariance matrices based on the conditional and unconditional multi-factor models does not improve the performance of the active asset allocation strategy relative to the incorporation of the historical covariance matrices. These results are fairly robust to different estimation approaches, as well as to the impact of transaction costs and the consideration of upper and lower bounds for the portfolio weights.

Ethical investing in Australia: Is there a financial penalty?

This study provides new evidence on the performance and investment style of retail ethical funds in Australia. By applying a conditional multi-factor model and after controlling for investment style, time-variation in betas and home bias, we observe no evidence of significant differences in risk-adjusted returns between ethical and conventional funds during 1992–2003. This result however is sensitive to the chosen time period. During 1992–1996 domestic ethical funds under-performed their conventional counterparts significantly, whereas during 1996–2003 ethical funds matched the performance of conventional funds more closely. This suggests that ethical mutual funds underwent a catching up phase, before delivering returns similar to those of conventional mutual funds.

Timing Ability in the Focus Market of Hedge Funds

This paper examines the timing ability of hedge funds covering various investment categories. We extend the Treynor-Mazuy (1966) and Henriksson-Merton (1981) market timing models to a multiple market framework and propose the concept of a focus market in which a fund trades most actively. Concentrating on the focus market enables us to parsimoniously apply conditional multifactor models. With a large sample of hedge funds during 1994-2002, we show evidence of significant timing ability in the focus markets including bond, currency, and equity markets at both the category and the fund levels. Tests of performance persistence present some supportive evidence over a short horizon.

The Conditional Price of Basis Risk: An Investigation Using Foreign Exchange Instruments

Abstract: This paper uses a conditional multifactor model and shows that the basis of foreign currency instruments includes a time‐varying risk premium that is related to the conditional risk of the basis and to the conditional prices of systematic risk present in all assets markets. The result therefore reinforces the view, initially put forward by Bailey and Chan (1993), that the basis is priced rationally in an efficient market. The article also shows that the premium for basis risk increases with the maturity of the instruments used for hedging.