Fund Portfolio Research Articles

Bayesian Nonparametric Measurement of Factor Betas and Clustering with Application to Hedge Fund Returns

We define a dynamic and self-adjusting mixture of Gaussian Graphical Models to cluster financial returns, and provide a new method for extraction of nonparametric estimates of dynamic alphas (excess return) and betas (to a choice set of explanatory factors) in a multivariate setting. This approach, as well as the outputs, has a dynamic, nonstationary and nonparametric form, which circumvents the problem of model risk and parametric assumptions that the Kalman filter and other widely used approaches rely on. The by-product of clusters, used for shrinkage and information borrowing, can be of use to determine relationships around specific events. This approach exhibits a smaller Root Mean Squared Error than traditionally used benchmarks in financial settings, which we illustrate through simulation. As an illustration, we use hedge fund index data, and find that our estimated alphas are, on average, 0.13% per month higher (1.6% per year) than alphas estimated through Ordinary Least Squares. The approach exhibits fast adaptation to abrupt changes in the parameters, as seen in our estimated alphas and betas, which exhibit high volatility, especially in periods which can be identified as times of stressful market events, a reflection of the dynamic positioning of hedge fund portfolio managers.

Stock portfolio design and backtest overfi tting

In mathematical finance, backtest overfitting connotes the usage of his- torical market data to develop an investment strategy, where too many variations of the strategy are tried, relative to the amount of data avail- able. Backtest overfitting is now thought to be a primary reason why investment models and strategies that look good on paper often disap- point in practice. In this study, we focus on overfitting in the context of designing an investment portfolio or stock fund. We demonstrate a computer program that, given any desired performance profile, designs a portfolio consisting of common securities, such as the constituents of the S&P 500 index, that achieves the desired profile based on in-sample back- test data. Unfortunately, the program also shows that these portfolios typically perform erratically on more recent, out-of-sample data, which is symptomatic of statistical overfitting. Less erratic results can be obtained by restricting the portfolio to positive-weight components, but then the results are quite unlike the target profile on both in-sample and out-of- sample data. One implication of these results is that so-called smart beta funds, which are designed in-sample to deliver a desirable performance profile, are likely to disappoint out-of-sample.

The Effect of Diversification on Tail Risk: Evidence from US Equity Mutual Fund Portfolios

This paper examines the effect of diversification on the tail risk of US equity mutual fund portfolios by utilizing classical higher-moment measures and robust tail weight measures. Empirical results show that market standard portfolios based on the mean-variance framework are exposed to greater tail risk than benchmark portfolios are and diversification further intensifies this exposure.

Measuring Hedge Fund Performance: A Markov Regime-Switching with False Discoveries Approach

We propose a Markov regime-switching approach accounting for false discoveries in order to measure hedge fund performance. It enables us to extract information from both time-series and cross-sectional dimensions of panels of individual hedge fund returns in order to distinguish between skilled, unskilled and zero-alpha funds for a given state of the economy. Applying our approach to individual hedge funds belonging to the Long/Short Equity Hedge strategy, we find that their performance cannot be explained by luck alone, and that the proportion of zero-alpha funds in the population decreases when accounting for alpha regime dependence. However, the proportion of truly skilled funds is higher during expansion periods, while unskilled funds tend to be more numerous during recession periods. Moreover, sorting on regime dependent alphas instead of unconditional alphas improves investors' ability to select funds that outperform their benchmarks in both regimes of the economy by maximizing the performance persistence effect of top performer fund portfolios.

Fund Portfolio Holdings and Affiliated Analyst's Objectivity: Do Equity and Employment Relationship Matter?

This paper investigates how the equity relationship between fund company and brokerage firm as well as employment relationship between analyst and brokerage firm affect affiliated fund stock portfolio holding and affiliated analyst’s objectivity. By using a specific data of such equity and employment relationship, we find that equity and employment relationship do matter in fund portfolio holdings and analyst’s objectivity. Specifically, analysts tend to release more optimal ratings on stocks that have been hold by the funds, and the funds tend to significantly reduce the stocks in their portfolio once the analysts have announced high ratings on the stocks. Moreover, the analysts in employment relationship with majority-shareholder of funds and with low reputation reveal worse objectivity. In addition, from the point of abnormal return, analysts in employment relationship with majority-shareholder of funds and with low reputation damage the interests of common investors.

Hedge Fund Tail Risk: An Investigation in Stressed Markets, Extended Version with Appendix

This paper develops several risk measures that captures the tail risk of single hedge fund strategies and the tail risk contribution of these hedge fund strategies to the overall portfolio tail risk, conditional on the level of market distress. We show that, during the recent global financial crisis, all the different hedge fund strategies are contributing to the tail risk of the portfolio of hedge funds, mostly because of the hedge fund strategies' exposure to liquidity and credit risk.

A Rational Theory of Mutual Funds' Attention Allocation

The question of whether and how mutual fund managers provide valuable services for their clients motivates one of the largest literatures in finance. One candidate explanation is that funds process information about future asset values and use that information to invest in high-valued assets. But formal theories are scarce because information choice models with many assets are difficult to solve as well as difficult to test. This paper tackles both problems by developing a new attention allocation model that uses the state of the business cycle to predict information choices, which in turn, predict observable patterns of portfolio investments and returns. The predictions about fund portfolios' covariance with payoff shocks, cross-fund portfolio and return dispersion, and their excess returns are all supported by the data. These findings offer new evidence that some investment managers have skill and that attention is allocated rationally.

ETF Positions within Actively Managed Mutual Fund Portfolios

We provide the first in-depth examination of exchange-traded funds (ETFs) within actively managed mutual fund (AMMF) portfolios to better understand why AMMFs make substantial investments in passive ETFs. We examine if holding ETF positions explains AMMF performance, as well as the impact an ETF position has on indirect measures of performance, including market timing, flow management, and cash holdings. We find that over one-third of AMMFs take an ETF position between 2004 and 2015. Our results indicate that AMMFs allocating large portions of their portfolio to ETFs perform worse, after controlling for style and characteristic differences, by between 0.40% and 1.63% annually using various performance measures. These AMMFs also exhibit worse market timing and hold more cash. In contrast, AMMFs that hold ETFs in small amounts have similar characteristics to non-user AMMFs. Therefore, the act of holding an ETF does not signal inferior ability, however, taking large ETF positions does.

A comparative study of the performance of Saudi mutual funds

This study examines the performance of 21 Saudi mutual funds using the CAPM and downside CAPM D-CAPM models over the period 2005-2011. Initially equity fund performance is examined against two benchmarks TASI and the GCCI Islamic index utilizing the traditional beta and CAPM performance evaluation measures. The evaluation is then replicated utilizing the downside beta and other tests of funds’ performance derived from the CAPM in the down side framework. The results indicate that the downside beta could be more relevant in terms of its higher explanatory power than the traditional beta and thus CAPM in the downside framework could be more relevant to report on funds’ performance in this emerging market. After exploring the aggregate performance by forming two fund portfolios; one representing the average Islamic mutual fund and the other is the average conventional fund, to examine the performance of the Islamic mutual funds portfolio compared to its conventional peers and to the overall market, the study finds, on average, Islamic mutual funds in outperform conventional mutual funds and the market portfolio. The study concludes that it is equally important for practitioners in emerging markets, to report performance using both CAPM measures and D-CAPM measures and if differences exist, then the D-CAPM could be the superior measure because of its suitability to the asymmetrical distribution of returns existing in emerging markets in general.

An AHP-based asset allocation model

With advances in the Brazilian stock market and the improvement in its economic foundation, it has become increasingly necessary for investors to conduct meticulous planning to determine the most suitable asset allocation. The identification of the characteristics and objectives of the investor is essential to determine a suitable portfolio. An integrated approach through the analytical techniques of multicriteria decision aiding has been shown to be suitable to finance. The scope of this study is to aid in this decision-making process so as to identify the investor suitability to the assets classes and provide diversification in mutual funds portfolio. The model used to identify the investor characteristics and analyse the alternatives in the decision-making process was the AHP method, through the use of the Super Decisions software. The final obtained result, besides a better understanding of the problem, was a ranking of assets classes leading to a portfolio selection.

Spanish Mutual Funds: Short-Term Performance and Market Timing

This paper examines the short-term performance and market timing ability of equity mutual funds in Spain between 1990 and 2015. Using a sample of daily returns, we document strong evidence of performance persistence and market timing ability across deciles in the post-ranking quarter. We document that not only the best and worst managers show persistence in the ability to select stocks. Our evidence is robust across several performance models and on the state of the business cycle. We also document that successful fund managers adjust the market exposure of fund portfolios in reaction to macroeconomic predictions. Our results suggest that a sample of Spanish mutual funds exploit the predictability of market returns documented in the finance literature and investors could obtain higher returns by following a simple buy-and-hold strategy.

Mexican REITs (FIBRAS) in retirement funds (AFORES): different pricing approaches and market risk measurement implications

This paper compares different pricing approaches for REITs and how they affect market risk measurement. Our study reveals that the Value at Risk valuation method used for REITs changes dramatically. This is an important issue for Mexican retirement funds. Our first valuation approach assumes that the REIT is a structured instrument consisting of a risky bond and an attached option on the value of a Mexican construction firm. The second alternative uses current data from FIBRA UNO (the largest Mexican REIT) as an uncertainty source. The third approach is developed by using an implicit net asset value (NAV) for FIBRA UNO, obtained as an indirect result of Merton's (1974) credit risk model. The fourth and last approach assumes that the REITs' market prices behave like small-caps with relatively low betas as stated in the literature. In all cases, the REITs are attached to a retirement fund portfolio subject to the Mexican regulation framework. Finally, we find empirical evidence of a high kurtosis on all the stylised portfolios, and that a high risk is assumed by retirement fund portfolios, despite their risk level should be associated with the age group of the affiliated workers.

Social Connections and Information Production: Evidence from Mutual Fund Portfolios and Performance

While connected investors have access to information in their social network (information diffusion effect), social connections also reduce their incentives to acquire costly information, since they can free-ride on connected peers (free-riding on friends effect). In this paper, I find this negative free-riding on friends effect of social connections dominates information diffusion effect in the mutual fund industry, using fund managers' connections built upon their prior career experiences. First, I find that connected funds are more likely to hold the same stocks and to trade in the same direction, relative to unconnected funds. Second, I find that funds with lower network centrality earn higher alphas, even after controlling for other fund and manager characteristics. A one-standard-deviation increase in eigenvector centrality predicts a decrease of 29-37 basis points in annualized fund alphas. Third, when I define a stock-level variable PMC (Peripheral minus Central) as the difference in average portfolio weights between peripheral funds and central funds, I find that stocks with higher PMC have significantly higher abnormal stock returns. A one-standard-deviation increase in PMC predicts an increase of 1.48%-1.52% in next quarter risk-adjusted returns (annualized). Finally, I find that PMC predicts firms' future earnings surprises.

Assessing the credit risk of money market funds during the eurozone crisis

This paper measures credit risk in prime money market funds (MMFs) and studies how such credit risk evolved during the eurozone crisis of 2011–2012. To accomplish this, we estimate the annualized expected loss on each fund's portfolio. We also calculate by Monte Carlo the cost of insuring a fund against losses amounting to over 50 basis points. We find that credit risk of prime MMFs, though small, doubled from 12 basis points in June 2011 to 23 basis points in December 2011 before receding in 2012. Contrary to common perceptions, this did not primarily reflect funds’ credit exposure to eurozone banks because funds took measures to reduce this exposure. Instead, credit risk in prime MMFs rose because of the deteriorating credit outlook of banks in the Asia/Pacific region. We conclude that the increase in the credit risk of prime MMFs in the second half of 2011 reflected contagion in the worldwide banking system coupled with slowing global economic growth, not actions taken by MMFs.

Default risk of money-market fund portfolios

We address the problem of quantifying the risk associated with money-market fund (MMF) portfolios. As MMFs are intended to be perpetual investment vehicles but hold short-maturity instruments, this problem presents some unique modeling challenges. By focusing on default risk, the most material driver of portfolio losses, and by using a constant level of risk assumption, we show how this problem is similar to that of pricing a collateralized debt obligation. Drawing upon this insight, we present a novel semianalytic approach to compute the default risk of MMF portfolios. Upon using this model to evaluate the portfolios of three of the largest prime MMFs, we find that they vary considerably in their default risk, which in our stylized model increases with the risk horizon. This suggests that to be effective and yet not punitive, any regulatory proposal (eg, establishing capital buffers, imposing liquidity fees, etc) to address the systemic risk posed by MMFs should be based on the riskiness of the MMF portfolios as well as their liquidation strategy.

An Empirical Study on the Performance of Select Large Cap Equity Mutual Funds in India

Since the opening up of the economy in the early 1990s, Indian mutual fund industry has witnessed fabulous quantitative growth. Funds which invest a larger proportion of their corpus in companies with large market capitalization are called large cap funds. Actively managed funds make use of a human element, such as a single manager, comanagers or a team of managers, to actively manage a fund's portfolio. The main objective of the study is to analyse the performance of select actively managed large cap equity funds in the line of risk-return parameters. This study is based on fourteen funds from twelve Asset Management Companies. All the funds are ranked under seven performance measures, namely, fund return, fund standard deviation, Sharpe Ratio, Treynor Ratio, return from systematic investment plan (SIP), Jensen Alpha, and RSQ, for five different time periods of 1-year, 3-year, 5-year, 7-year, and 10-year.

The People in Your Neighborhood: Social Interactions and Mutual Fund Portfolios

ABSTRACTWe find that socially connected fund managers have more similar holdings and trades. The overlap of funds whose managers reside in the same neighborhood is considerably higher than that of funds whose managers live in the same city but in different neighborhoods. These effects are larger when managers share a similar ethnic background, and are not explained by preferences. Valuable information is transmitted through these peer networks: a long‐short strategy composed of stocks purchased minus sold by neighboring managers delivers positive risk‐adjusted returns. Unlike prior empirical work, our tests disentangle the effects of social interactions from community effects.

Hedge Fund Portfolio Strategy Based on Performance Persistence and Portfolio Theory

This paper aims to analyze and develop systematic methods to construct funds of funds (FOF) products investing in Chinese hedge funds, with low risk, high return and high Sharpe Ratio, or other ideal characteristics required by investors. Using performance data of more than 600 hedge funds, we applied standard portfolio theory to design portfolios with optimized risk and return features. Tradable FOF products with low risk, high return and high Sharpe Ratio were described in detail, with outstanding performances confirmed by systematic backtest and robust tests. Collectively, our results offer a sound investing product based on Chinese hedge fund performance, and are valuable both as an independent product and as a major component in a more comprehensive portfolio.

Private ethical fund investors across countries and time: a survey-based review

Purpose – This paper aims to provide an overview of the literature to point out similarities and differences among private ethical investors across countries and time. Over the past three decades, many surveys have been conducted to advance the understanding of the demographic characteristics, motivation and morals of private ethical investors across countries and time. To date, the survey-based evidence on private investors into ethical funds is geographically rather segmented, and the research questions are fairly diverse. This permits only very temporally or regionally selective conclusions. Thereby, the authors identify interesting topics for future research. Design/methodology/approach – To identify the relevant literature for our review, the authors carried out a structured Boolean keyword search using major library services and databases. Findings – When questions about negative screening criteria are presented in a direct investment context, the consensus of private ethical investors “worldwide” (on average) is that social screening issues are most important, followed by ecological and moral topics. The percentage of ethical funds in the fund portfolio of the average private ethical investor in Europe seems to increase when the investor exhibits high degrees of pro-social attitudes and perceived consumer effectiveness. European private ethical investors are of the opinion that ethical funds perform worse but are less risky than conventional funds. Practical implications – The authors make suggestions on how investment companies should design their funds so that they can attract more socially responsible investors. Originality/value – The paper is of particular value because it focuses on private investors in the fast growing retail market of socially responsible investment funds.

The Impact of Hedge Funds on Asset Markets

While there has been enormous interest in hedge funds from academics, prospective and current investors, and policymakers, rigorous empirical evidence of their impact on asset markets has been di¢ cult to …nd. We construct a simple measure of the aggregate illiquidity of hedge fund portfolios, and show that it has strong in- and out-of-sample forecasting power for 72 portfolios of international equities, corporate bonds, and currencies over the 1994 to 2011 period. The forecasting ability of hedge fund illiquidity for asset returns is in most cases greater than, and provides independent information relative to, well-known predictive variables for each of these asset classes. We construct a simple equilibrium model to rationalize our …ndings, and empirically verify auxiliary predictions of the model.