Fund Portfolio Research Articles

Geography, Informal Information Flows and Mutual Fund Portfolios

This paper explores how informal information channels impact mutual fund performance. We measure the strengths of two location‐based information channels: 1) information transfers among fund managers (fund‐fund links) and 2) transfers between managers and the companies in which they invest (fund‐company links). We find that each channel increases investment performance in the absence of the other, but decreases it when acting in combination. Stock selection associated with the presence of one channel, but the absence of the other, earns positive future returns. Our results indicate that the economic benefits of informal information channels depend critically on the nature of their interactions.

Long/Short Equity Hedge Funds and Systematic Ambiguity

This study presents the hedge fund portfolio choice model for an investor facing ambiguity or Knightian uncertainty. In the empirical section, we measure ambiguity as the cross-sectional dispersion in the macroeconomic forecasts and in the stock market return forecasts from the Livingston Survey and construct the systematic ambiguity factors from the universe of S&P 500 stocks. We estimate ambiguity betas for long/short equity hedge funds strategies and document signicant ambiguity exposures for directional L/S hedge funds. We compare the out-of-sample performance of portfolios constructed according to the L/S hedge funds alpha ranking with and without systematic ambiguity exposures and nd that the former outperform. These

Polynomial goal programming and the implicit higher moment preferences of US institutional investors in hedge funds

Polynomial goal programming (PGP) is a flexible method that allows investor preferences for different moments of the return distribution of financial assets to be included in the portfolio optimization. The method is intuitive and particularly suitable for incorporating investor preferences in higher moments of the return distribution. However, until now, PGP has not been able to meet its full potential because it requires quantification of “real” preference parameters towards those moments. To date, the chosen preference parameters have been selected somewhat “arbitrarily”. Our goal is to calculate implied sets of preference parameters using investors’ choices of and the importance they attribute to risk and performance measures. We use three groups of institutional investors—pension funds, insurance companies, and endowments—and derive implied sets of preference parameters in the context of a hedge fund portfolio optimization. To determine “real” preferences for the higher moments of the portfolio return distribution, we first fit implied preference parameters so that the PGP optimal portfolio is identical to the desired hedge fund portfolio. With the obtained economically justified sets of preference parameters, the well-established PGP framework can be employed more efficiently to derive allocations that satisfy institutional investor expectations for hedge fund investments. Furthermore, the implied preference parameters enable fund of hedge fund managers and other investment managers to derive optimal portfolio allocations based on specific investor expectations. Moreover, the importance of individual moments, as well as their marginal rates of substitution, can be assessed.

Portfolio Spillovers and a Limit to Diversification

Securities are exposed to the return shocks of seemingly unrelated securities in common mutual fund portfolios. Shocks to firm returns mechanically affect fund returns that hold these securities, which induce investor-driven flows and rebalancing, resulting in temporary flow-induced price pressure (FIPP) on other firms in common portfolios. Instrumenting to address flow/return endogeneity, a one standard deviation increase in the FIPP corresponds to a 15-60 bps increase in daily abnormal firm returns. This pressure reverses in 5-6 days and is larger for liquid firms and for funds experiencing outflows. Failing to properly estimate this correlation implies that an investor is exposed to nonsystematic risk.

Hedge Fund Politics and Portfolios

Consistent with the well-documented relation between political orientation and psychological traits, hedge funds’ political orientations are related to their portfolio decisions. Relative to politically conservative hedge funds, politically liberal hedge funds exhibit a preference for smaller stocks, less mature companies, volatile stocks, unprofitable companies, non-dividend paying companies, and lottery-type securities. Politically liberal hedge funds are also more likely to enter new positions or fully exit existing positions, and make larger adjustments to their U.S. equity market exposure. Our results suggest that psychological characteristics can influence the portfolio decisions of even those at the very top of the financial sophistication ladder.

Long/Short Equity Hedge Funds and Systematic Ambiguity

This study presents a hedge fund portfolio choice model for an investor facing ambiguity. In the empirical section, we measure ambiguity as the cross-sectional dispersion in Industrial Production growth and in stock market return forecasts, and we construct the systematic ambiguity factors from the universe of S&P 500 stocks. We estimate ambiguity betas for long/short equity hedge funds strategies and document signi cant ambiguity exposures for directional L/S equity hedge funds. We compare the out-of-sample performance of portfolios constructed according to the L/S hedge fund alphas' ranking with and without systematic ambiguity exposures and nd that the former outperform.

Implementing Global Fund programs: a survey of opinions and experiences of the Principal Recipients across 69 countries

BackgroundPrincipal Recipients (PRs) receive money from the Global Fund to fight AIDS, Tuberculosis and Malaria (Global Fund) to manage and implement programs. However, little research has gone into understanding their opinions and experiences. This survey set out to describe these, thereby providing a baseline against which changes in PR opinions and experiences can be assessed as the recently introduced new funding model is rolled out.MethodologyAn internet based questionnaire was administered to 315 PRs. A total of 115 responded from 69 countries in Africa, Asia, Eastern Europe and Latin America. The study was conducted between September and December 2012.FindingsThree quarters of PRs thought the progress update and disbursement request (PU/DR) system was a useful method of reporting grant progress. However, most felt that the grant negotiation processes were complicated, and that the grant rating system did not reflect performance.While nearly all PRs were happy with the work being done by sub-Recipients (92%) and Fund Portfolio Managers (86%), fewer were happy with the Office of the Inspector General (OIG). Non-government PRs were generally less happy with the OIG’s work compared to government PRs.Most PRs thought the Global Fund’s Voluntary Pooled Procurement system made procurement easier. However, only 29% said the system should be made compulsory.When asked which aspects of the Global Fund’s operations needed improvement, most PRs said that the Fund should re-define and clarify the roles of different actors, minimize staff turnover at its Secretariat, and shorten the grant application and approval processes. All these are currently being addressed, either directly or indirectly, under a new funding model. Vigorous assessments should nonetheless follow the roll-out of the new model to ensure the areas that are most likely to affect PR performance realize sustained improvement.ConclusionsOpinions and experiences with the Global Fund were varied, with PRs having good communication with Fund Portfolio Managers and sub-Recipients, but being unhappy with the grant negotiation and grant rating systems. Recommendations included simplifying grant processes, finding performance assessment methods that look beyond numbers, and employing Local Fund Agents who understand public health aspects of programs.

The Effect of Sustainability on Retail Values, Rents, and Investment Performance: European Evidence

This paper is the first to focus on the effects of sustainability on the investment performance of a European retail portfolio comprising 128 properties in the Netherlands and extends the existing range of studies on the office and residential sectors in the United States. As the data sample is an existing fund portfolio, all attributes of the properties are known. Environmental sustainability is measured by the Dutch energy label, which compares with ENERGY STAR in the U.S. Through OLS regressions, we examine whether a sustainability premium exists. We find that green retail properties have a significantly higher income return of 0.52%, while, counterintuitively, non-green retail properties appear to have significantly higher rents and values. After controlling for various factors, however, the sustainability effects become insignificant. This contradicts some of the findings in the office and residential sectors. We attribute this to the importance of traditional retail location theory factors, which continue to dominate returns.

Return or position-based value at risk?

The emergence of managed account platforms for investing in hedge funds has given the investor access to a range of new risk measures. This study analyses the accuracy of various value at risk (VaR) methodologies in the context of hedge fund investing. In our sample of data, we found that position-based VaR provides the best risk assessment measure for short horizons (up to five days). For longer term horizons (five days or more), position-based VaR can sometimes be inaccurate. Our interpretation is that, despite being based on actual underlying positions, position-based VaR is not designed to capture the dynamic of hedge fund portfolios. Over longer term horizons, VaR calculated using historic returns still provides a rough but reliable risk indicator for the investor. Our study also highlights the importance of regular monitoring of any risk model’s accuracy in its specific context.

Portfolio Flows, Global Risk Aversion and Asset Prices in Emerging Markets

In recent years, portfolio flows to emerging markets have become increasingly large and volatile. Using weekly portfolio fund flows data, the paper finds that their short-run dynamics are driven mostly by global “push” factors. To what extent do these cross-border flows and global risk aversion drive asset volatility in emerging markets? We use a Dynamic Conditional Correlation (DCC) Multivariate GARCH framework to estimate the impact of portfolio flows and the VIX index on three asset prices, namely equity returns, bond yields and exchange rates, in 17 emerging economies. The analysis shows that global risk aversion has a significant impact on the volatility of asset prices, while the magnitude of that impact correlates with country characteristics, including financial openness, the exchange rate regime, as well as macroeconomic fundamentals such as inflation and the current account balance. In line with earlier literature, portfolio flows to emerging markets are also found to affect the level of asset prices, as was the case in particular during the global financial crisis.

Portfolio Flows, Global Risk Aversion and Asset Prices in Emerging Markets

In recent years, portfolio flows to emerging markets have become increasingly large and volatile. Using weekly portfolio fund flows data, the paper finds that their short-run dynamics are driven mostly by global “push” factors. To what extent do these cross-border flows and global risk aversion drive asset volatility in emerging markets? We use a Dynamic Conditional Correlation (DCC) Multivariate GARCH framework to estimate the impact of portfolio flows and the VIX index on three asset prices, namely equity returns, bond yields and exchange rates, in 17 emerging economies. The analysis shows that global risk aversion has a significant impact on the volatility of asset prices, while the magnitude of that impact correlates with country characteristics, including financial openness, the exchange rate regime, as well as macroeconomic fundamentals such as inflation and the current account balance. In line with earlier literature, portfolio flows to emerging markets are also found to affect the level of asset prices, as was the case in particular during the global financial crisis.

Portfolio Capital Flows: A Simple Coincident Indicator for Emerging Markets

The scarcity of up-to-date data is a meaningful constraint in the analysis of capital flows, especially for Emerging Markets (EMs). Indeed, the most commonly used source of cross-country data on capital flows is the Balance of Payments (BoP) statistics collected by the International Monetary Fund. Nevertheless, these data are available at low frequency and are usually published three to nine months later, notably for EMs. This delay is problematic for policy makers who need to calibrate appropriate policies in order to control the pernicious effects of volatile foreign capital flows, i.e. economic and financial imbalances resulting from surges and/or sudden stops. To address this issue, we propose a simple coincident proxy to capture the gross portfolio capital flows towards EMs. This indicator is a metric of the current state of these portfolio flows and uses data from Emerging Portfolio Fund Research (EPFR) Global which covers net bond and equity flows. In an error correction framework, we propose to better capture foreign investors’ sentiment. We find that the trend in EPFR data is a coincident indicator of BoP flows mainly in regional aggregates and large EMs. Finally, we build some Investor Sentiment indices that provide relevant information on EM asset returns.

Socially responsible funds and market crises

Compared to matched conventional mutual funds, socially responsible mutual funds outperform during periods of market crises. This dampening of downside risk comes at the cost of underperforming during non-crisis periods. Investors seeking downside protection would value the asymmetry of these returns. This asymmetric return pattern is driven by the mutual funds that focus on environmental, social, or governance (ESG) attributes and is especially pronounced in ESG funds that use positive screening techniques. Furthermore, the observed patterns are attributed to the funds’ socially responsible attributes and not the differences in fund portfolio management or the characteristics of the companies in fund portfolios.

Empirical analysis on future-cash arbitrage risk with portfolio VaR

This paper constructs the positive arbitrage position by alternating the spot index with Chinese Exchange Traded Fund (ETF) portfolio and estimating the arbitrage-free interval of futures with the latest trade data. Then, an improved Delta-normal method was used, which replaces the simple linear correlation coefficient with tail dependence correlation coefficient, to measure VaR (Value-at-risk) of the arbitrage position. Analysis of VaR implies that the risk of future-cash arbitrage is less than that of investing completely in either futures or spot market. Then according to the compositional VaR and the marginal VaR, we should increase the futures position and decrease the spot position appropriately to minimize the VaR, which can minimize risk subject to certain revenues.

An empirical approach on regulating China’s pension investment

A prerequisite for preserving and increasing the value of pension funds is to make an appropriate investment with them; for this purpose most countries have issued regulation to guide the pension investment. After conducting an empirical analysis of different investment portfolios, e.g. Bank deposit, Treasury bond, and Equity in China, this paper reaches the following conclusions. Observing the strict limitation on quantity, the public equity ratio in portfolios of pension funds should be controlled below 20 %. To alleviate the “Home Bias” in investment, as well as to avoid the systematic risks intrinsic of the investing within a single country as China, some part of pension funds investment should be allowed to be invested into overseas markets. The constraints on public equity investment may be liberalized and the prudential person rule of pension investment in Common Law could be imported into pension legislation amendments when the Chinese stock market and legal system is more developed and going mature.

Regulating China's Pension Investment into the Stock Market: An Empirical Study

A prerequisite for preserving and increasing the value of pension funds is to make an appropriate investment with them; for this purpose most countries have issued regulation to guide the pension investment. After conducting an empirical analysis of different investment portfolios, e.g. Bank deposit, Treasury bond, and Equity in China, this paper reaches the following conclusions. Observing the strict limitation on quantity, the public equity ratio in portfolios of pension funds should be controlled below 20%. To alleviate the ‘‘Home Bias’’ in investment, as well as to avoid the systematic risks intrinsic of the investing within a single country as China, some part of pension funds investment should be allowed to be invested into overseas markets. The constraints on public equity investment may be liberalized and the prudential person rule of pension investment in Common Law could be imported into pension legislation amendments when the Chinese stock market and legal system is more developed and going mature.

When times get tough, gold is golden

We investigate the dynamic behaviour of conditional correlations between the US market, gold and two gold financial proxies using a multivariate dynamic conditional correlation model over different market regimes. A comprehensive period of time is analysed covering approximately 37 years of daily data, from August 1976 to March 2013, as well as a shorter period, of about 15 years, from September 1998 to March 2013. Both periods include the recent sub-prime financial crisis. Market regimes are defined using bull/bear states and alternatively using volatility regimes from a three-state Markov-switching variance model. An index of US mining companies and a value-weighted portfolio of US gold mutual funds are treated as potential proxies for an investment in gold. Two important conclusions emerge from our study. The first is that, even in the context of a dynamic correlation analysis, gold is always a safe haven; negatively correlated with the stock market under adverse market conditions. The second is that, although the gold proxies considered here exhibit a low correlation with the stock market and therefore offer diversification benefits, they cannot be considered perfect substitutes of gold due to their lack of negative correlations with the market in times of turmoil.

Idiosyncratic Risk and Cross Section of Hedge Fund Returns

This paper examines the extent to which idiosyncratic risk measures explain cross-sectional differences in hedge fund returns. Using exponential GARCH models to estimate conditional idiosyncratic volatility, we find a significant positive relation between conditional idiosyncratic volatility (E(IVOL)) and expected hedge fund returns. The portfolio of hedge funds with highest E(IVOL) outperforms that with the lowest E(IVOL) by 0.65% per month (7.8% per annum), over the period January 1998 to December 2011. This relation remains positive and highly significant after controlling for fund characteristics and momentum effects. Idiosyncratic risk is a powerful factor in explaining the cross-sectional variation in hedge fund returns.

Portfolio Monitoring Costs, Mutual Fund Fees and Portfolio Diversification

Investors select from the continuum of investment choices. Almost one in every two households make a very special investment choice, they invest in mutual funds. Empirically, mutual funds underperform, especially net of fees. When making financial decisions is associated with a monitoring cost, the investor may optimally agree to pay high fees to fund managers of an average or even inferior investment ability and to pay for passive indexing. Models without frictions and models with more traditional types of frictions, transaction costs and search costs, can not explain such mutual fund investments. I compare sensitivity of acceptable mutual fund fees to monitoring costs and to transaction costs. If index fund managers exactly replicate the market in expectation, an investor facing low monitoring costs of .01% could be willing to pay a 4.38% load or a 2.78% management fee for delegated indexing. Unrealistically high proportional transaction costs of 3% are consistent with a 3.66% load or a .68% management fee. While transaction costs could possibly explain most of the observed loads, they cannot explain the range of the observed management fees. Search costs may explain the coexistence of different index mutual fund fees, but not the level of fees. In addition to the empirically observed mutual fund fee structures, even modest levels of monitoring costs do explain a wide array of other empirically-observed investment choices as well. In particular, some investors should optimally hold an undiversified portfolio of individual stocks, while others should combine directly held stocks with mutual fund investments, yet another group of investors should opt to own no risky assets at all.

Measuring fund style, performance and activity: a new style-profiling approach

We construct new measures of fund style, performance and activity from linear combinations of off-the-shelf stock-market indices. A fund's benchmark portfolio is a linear combination of two or more reference portfolios that in a least-squares sense most closely approximates the fund's portfolio. The resulting linear combination scalar is itself a measure of fund style and the distance between a fund and its benchmark is a measure of fund activity. Our approach has a number of advantages over existing characteristic-matching methods. We illustrate our approach using a data set of US institutional funds.