Higher Risk-adjusted Performance Research Articles

Assessing the Performance and Risk-Adjusted Returns of Financial Mutual Funds

In this study, we provide a comprehensive examination of the performance of financial (specialty sector financial) mutual funds over a 23-year period, a much longer time frame than what has been analyzed in previous literature. To fully understand the performance of these mutual funds, we consider multiple factors, including risk-adjusted performance, both unconditional and conditional multifactor analysis, and market timing and selectivity. Financial mutual funds have higher risk-adjusted performance than the overall market and financial sector benchmarks. However, fund alphas are not different from zero, and managers do not exhibit market timing or security selection abilities. Our analysis not only includes the overall performance of these mutual funds, but we also delve into sub-samples before and after the 2008 financial crisis and during the recent Coronavirus pandemic.

Relative Performance of Real Estate Exchange-Traded Funds

This paper examines the performance of 34 real estate exchange-traded funds (REETFs) over the period of May 2003 through September 2019. We construct equally-weighted REETF portfolios every month and compare them with the overall U.S. stock market as proxied by the S&P 500 value-weighted ETF (IVV) and the S&P 500 equal-weighted ETF (RSP). Our results show that over the entire time period the REETF portfolios experienced higher monthly returns, but also had a slightly higher standard deviation of returns. We also provide results controlling for risk differentials using the Sharp, Sortino, and Omega ratios. The results show that IVV and RSP had higher risk-adjusted performance using all of the various measures compared with REETFs portfolios. REETFs also had much higher risk and losses during the 2007–2009 financial crisis.

Option Writing: Using VIX to Improve Returns

Buy-write and put-write strategies have been shown to match market returns with lower volatility, resulting in higher risk-adjusted performance. The strategies benefit from the fact that the implied volatility of options is generally higher than actual realized volatility. In this article, we show that this premium is higher at elevated levels of implied volatility (as represented by the VIX index level). Based on this finding, we propose a simple conditional strategy in which one sells options at elevated levels of the VIX. Using data from 1990 through 2018, we find that this conditional strategy outperforms both the market and continuous option-selling strategies on an absolute and risk-adjusted basis.

Performance of Female CEOs

The authors examine the performance of companies led by women from January 1996 to December 2014. The results show that companies headed by women outperformed the U.S. market, as proxied by the S&P 1500 and Russell 3000 indexes. Firms with female CEOs have higher average and median monthly returns, higher risk (standard deviation of monthly returns), and higher risk-adjusted performance (Sharpe, Sortino, and Omega ratios). Female-led companies also have significantly positive alphas with both the Carhart four-factor model and the Fama–French five-factor model when they form equally weighted and value-weighted portfolios of these firms. These results indicate that firms led by women have created significant value for their investors during the period of our study.

The Promises and Pitfalls of Robo-Advising

We study a robo-advising portfolio optimizer that constructs tailored strategies based on in- vestors’ holdings and preferences. Adopters are similar to non-adopters in terms of demographics, but have more assets under management, trade more, and have higher risk-adjusted performance. The robo-advising tool has opposite effects across investors with different levels of diversification before adoption. It increases portfolio diversification and decreases volatility for those that held less than 5 stocks before adoption. These investors’ portfolios perform better after using the tool. At the same time, robo-advising barely affects diversification for investors that held more than 10 stocks before adoption. These investors trade more after adoption with no effect on average performance. For all investors, robo-advising reduces - but does not fully eliminate - pervasive behavioral biases such as the disposition effect, trend chasing, and the rank effect, and increases attention based on online account logins. Our results emphasize the promises and pitfalls of robo-advising tools, which are becoming ubiquitous all over the world.

The Promises and Pitfalls of Robo-Advising

We study a robo-advising portfolio optimizer that constructs tailored strategies based on in- vestors’ holdings and preferences. Adopters are similar to non-adopters in terms of demographics, but have more assets under management, trade more, and have higher risk-adjusted performance. The robo-advising tool has opposite effects across investors with different levels of diversification before adoption. It increases portfolio diversification and decreases volatility for those that held less than 5 stocks before adoption. These investors’ portfolios perform better after using the tool. At the same time, robo-advising barely affects diversification for investors that held more than 10 stocks before adoption. These investors trade more after adoption with no effect on average performance. For all investors, robo-advising reduces - but does not fully eliminate - pervasive behavioral biases such as the disposition effect, trend chasing, and the rank effect, and increases attention based on online account logins. Our results emphasize the promises and pitfalls of robo-advising tools, which are becoming ubiquitous all over the world.

Option Writing: Using VIX to Improve Returns

Buy-Write and Put-Write strategies have been shown to match market returns with lower volatility resulting in higher risk-adjusted performance. The strategies benefit from the fact that implied volatility of options is generally higher than actual realized volatility. In this paper we show that this premium is higher at elevated levels of implied volatility (as represented by the VIX index level). Based on this finding we propose a simple conditional strategy in which one sells options at elevated levels of the VIX. Using data from 1990 through 2018, we find that this conditional strategy outperforms both the market and continuous option selling strategies on an absolute and risk-adjusted basis.

Combining Multivariate Volatility Forecasts: An Economic-Based Approach

We devise a novel approach to combine predictions of high-dimensional conditional covariance matrices using economic criteria based on portfolio selection. The combination scheme takes into account not only the portfolio objective function but also the portfolio characteristics in order to define the mixing weights. Three important advantages are that i) it does not require a proxy for the latent conditional covariance matrix, ii) it does not require optimization of the combination weights, and iii) can be calibrated in order to adjust the influence of the best performing models. Empirical application involving a data set with 50 assets over a 10-year time span shows that the proposed economic-based combinations of multivariate volatility forecasts leads to mean–variance portfolios with higher risk-adjusted performance in terms of Sharpe ratio as well as to minimum variance portfolios with lower risk on an out-of-sample basis with respect to a number of benchmark specifications.

Does it pay to diversify?

Individual investors seek diversification in their portfolios using a number of approaches. One approach that is commonly used is to diversify globally. This article evaluates the performance and diversification benefits of international ETFs for U.S. investors during and after the recent financial crisis. Our results show that U.S. ETFs outperform all categories of international ETFs for the period of our study (January 2008 – June 2013); they have higher average monthly returns, lower risk (standard deviation of returns), higher risk-adjusted performance (Sharpe, Sortino, and Treynor ratios) and the highest cumulative returns over the entire period. When we form equally weighted portfolios of each ETF category and compute their risk-adjusted performance, we again find that U.S. ETF portfolios had the best performance for the entire period. We also find that U.S. ETFs have the lowest tracking error during the entire period. Most of these ETFs passively track the benchmark and do not manage for positive ɑ. Previous research has questioned the diversification benefits of international investing during times of financial distress. We find that international ETFs are highly dependent on major U.S. indices during the period of our analysis, and therefore, offered limited diversification benefits for U.S. investors.

Combining Multivariate Volatility Forecasts: An Economic-Based Approach

We devise a novel approach to combine predictions of high dimensional conditional covariance matrices using economic criteria based on portfolio selection. The combination scheme takes into account not only the portfolio objective function but also the portfolio characteristics in order to define the mixing weights. Three important advantages are that i) it does not require a proxy for the latent conditional covariance matrix, ii) it does not require optimization of the combination weights, and iii) it holds the equally-weighted model combination as a particular case. Empirical applications involving three large data sets from different markets show that the proposed economic-based combinations of multivariate GARCH forecasts leads to mean-variance portfolios with higher risk-adjusted performance in terms of Sharpe ratio as well as to minimum variance portfolios with lower risk on an out-of-sample basis with respect to a number of benchmark specifications.

The scope of international mutual fund outsourcing: Fees, performance and risks

This paper examines the causes and consequences of mutual fund outsourcing to different types of service providers: advisors, custodians, administrators, and transfer agents. The data indicate outsourcing is less common among bank-managed funds, funds of leading groups, but more common among funds that are distributed through third parties. Moreover, initial subscription fees are lower among funds that outsource non-advisory services, while annual management fees are not different among funds that outsource. The effect of service outsourcing on subscription fees occurs only for funds targeting institutional investors; retail investors enjoy no fee gains. The outsourcing of advisor services is associated with greater fund risk, but also with higher risk-adjusted performance (Sharpe ratio). However, the positive link with performance disappears when controlling for endogeneity, suggesting that fund managers optimally outsource advisory services in response to expected performance gains. Consistent with our predictions, outsourcing of other services does not impact portfolio decisions. Their impact is through lower subscription fees.

The Scope of International Mutual Fund Outsourcing: Fees, Performance and Risks

This paper examines the causes and consequences of mutual fund outsourcing to different types of service providers: advisors, custodians, administrators, and transfer agents. The data indicate outsourcing is less common among bank-managed funds, funds of leading groups, but more common among funds that are distributed through third parties. Moreover, initial subscription fees are lower among funds that outsource non-advisory services, while annual management fees are not different among funds that outsource. The effect of service outsourcing on subscription fees occurs only for funds targeting institutional investors; retail investors enjoy no fee gains. The outsourcing of advisor services is associated with greater fund risk, but also with higher risk-adjusted performance (Sharpe ratio). However, the positive link with performance disappears when controlling for endogeneity, suggesting that fund managers optimally outsource advisory services in response to expected performance gains. Consistent with our predictions, outsourcing of other services does not impact portfolio decisions. Their impact is through lower subscription fees.

Creating More Stable and Diversified Socially Responsible Investment Portfolios

This study is the first to apply a robust estimation technique when constructing Socially Responsible Investing (SRI) portfolios and to highlight that the selection of the optimization process in this industry matters. We go beyond the mean-variance Markowitz framework in order to bypass issues surrounding the significant estimation risk that causes unstable, poorly diversified and suboptimal portfolios. Using data from MSCI KLD on the social responsibility of US firms, we construct SRI portfolios which exhibit higher risk-adjusted performance, lower total risk, greater stability and diversification compared to conventional and SRI equity indexes, as well as more naive forms of optimization. Our main conclusions are robust to a series of tests, including the use of different estimation windows, stricter screening criteria, and alternative ways of evaluating portfolio performance.

Diversifying Diversification Strategies: Model Averaging in Portfolio Optimization

The literature on portfolio optimization in the presence of parameter uncertainty has suggested several approaches to mitigate the impact of estimation error on portfolio performance. However, empirical evidence finds no single approach that can achieve a consistently higher risk-adjusted performance than 1/N. In this paper, I propose three averaging rules that synthesize the established approaches in order to mitigate the impact of estimation error on portfolio performance. The evaluation of the proposed averaging rules on empirical and simulated datasets shows that each rule achieves a consistently higher risk-adjusted performance than 1/N, while all individual portfolio strategies considered in the averaging exercise do not. I find that the observed performance gains are economically and statistically significant. The performance gains are attributable to persistent diversification effects between the portfolio strategies under consideration, as well as to empirical characteristics in portfolio returns that are exploited by one of the averaging rules.

The Canadian Hedge Fund Industry: Performance and Market Timing

We analyze the risk and return characteristics of Canadian hedge funds based on a comprehensive database we compiled. We find that Canadian hedge funds have higher risk-adjusted performance and different distributional characteristics relative to the global hedge fund indices. We investigate market timing by Canadian hedge funds and find that they do not time the Canadian or global stock and bond markets, but hedge funds in the Managed Futures strategy group time the commodity market. These results are robust to parameter instability and structural changes in the model. We also illustrate the impact of using local and global risk factors to analyze the performance of local investment firms.

Disposition effect and mutual fund performance

This article finds strong evidence for the presence of the disposition effect among US mutual fund managers. The analysis can establish a link between the disposition effect and mutual fund characteristics as well as changes in the macroeconomic environment. Managers with a lower disposition effect are found to invest in larger equities with a higher trade volume, a higher past performance, lower idiosyncratic risk, and a higher risk-adjusted performance. However, fund characteristics and the economic environment can only explain a limited amount of the variation in the disposition effect across mutual funds. Using a new methodology to reduce the disposition effect exhibited by mutual fund investments, we find no increase in their profitability. Although statistically significant, the disposition effect has only a minor economic effect on fund performance.

Disposition Effect and Mutual Fund Performance

This article finds strong evidence for the presence of the disposition effect among US mutual fund managers. The analysis can establish a link between the disposition effect and mutual fund characteristics as well as changes in the macroeconomic environment. Managers with a lower disposition effect are found to invest in larger equities with a higher trade volume, a higher past performance, lower idiosyncratic risk, and a higher risk-adjusted performance. However, fund characteristics and the economic environment can only explain a limited amount of the variation in the disposition effect across mutual funds. Using a new methodology to reduce the disposition effect exhibited by mutual fund investments, we find no increase in their profitability. Although statistically significant, the disposition effect has only a minor economic effect on fund performance.