Higher Risk-adjusted Returns Research Articles

Using Precious Metals to Reduce the Downside Risk of FinTech Stocks

FinTech stocks are an important new asset class that reflects the rapidly growing FinTech sector. This paper studies the practical implications of using gold, silver, and basket-of-precious-metals (gold, silver, platinum, palladium) ETFs to diversify risk in FinTech stocks. Downside risk reduction is estimated using relative risk ratios based on CVaR. The analysis shows that gold provides the most downside risk protection. For a 5% CVaR, a 30% portfolio weight for gold reduces the downside risk by about 25%. The minimum variance and minimum correlation three-asset (FinTech, gold, and silver) portfolios (with portfolio weights estimated using a TVP-VAR model) have the highest risk-adjusted returns (Sharpe ratio, Omega ratio) followed by the fixed-weight FinTech and gold portfolio. These results show the benefits of diversifying an investment in FinTech stocks with precious metals. These results are robust to weekly or monthly portfolio rebalancing and reasonable transaction costs.

Connectedness between energy cryptocurrencies and US equity markets: A quantile-based analysis

Energy cryptocurrencies emerge as a new class of digital assets for morally conscientious investors to build long-term portfolios with high risk-adjusted returns. Focusing on this unique asset class, the current study investigates the static and dynamic spillovers between energy cryptocurrencies and US equity sector stocks at various quantiles. We apply the quantile VAR technique on the selected sample of four energy cryptocutrrencies and eleven major US equity markets for February 27, 2018 to November 25, 2022. This period includes two important subperiods: COVID-19 and the Russian-Ukraine War. Our findings support higher connectedness levels at the extreme lower and upper quantiles compared to the mean and median quantiles. While all energy cryptocurrencies are shock receivers at the extreme lower quantile, the majority of US equity sector stocks are shock transmitters at the lower quantile. The IT sector is a shock receiver at all quantiles, whereas the energy sector is a shock transmitter. Overall connectedness fluctuates over time and shows a significant rise at the start of the COVID period. Our results provide insights to investors, portfolio managers, and policymakers regarding portfolio allocation, forecasting, and risk management during downward and upward market conditions. Additionally, the ideal hedge ratios slightly increased during the COVID-19 pandemic, which increased the cost of asset coverage.

Robust portfolio selection with smart return prediction

Return prediction and portfolio decision are closely connected steps in forming optimal portfolios. However, existing studies often separate return prediction from portfolio decisions or overlook the high sensitivity of optimal portfolios to estimated returns, leading to poor out-of-sample performance. To address these two issues simultaneously, this paper proposes a robust portfolio framework that optimizes parameters in return prediction by maximizing robust mean–variance utility. The proposed framework effectively combines return prediction and portfolio decisions while mitigating the uncertainty in return prediction. Empirical analysis on S&P500 constituents demonstrates that, compared to the benchmarks, the proposed framework achieves lower risk and higher risk-adjusted returns, originating from more stable weight estimation and diversified portfolios. Further, we uncover that the market friction characteristics considerably contribute to the proposed strategies’ performance. Our results suggest that integrating return prediction with the robust mean–variance models can significantly improve portfolio performance.

Comparative Analysis of Private and Public Mutual Funds: A Performance Evaluation

Abstract: The mutual fund industry is a popular investment avenue that offers investors the opportunity to invest in a diversified portfolio of securities. The industry has witnessed significant growth in recent years, with investors seeking to maximize their returns and reduce risk. This paper presents a comprehensive comparative analysis of private and public mutual funds in terms of their performance. The study aims to evaluate the risk-adjusted returns, expense ratios, fund size, asset allocation, and other relevant factors of both private and public mutual funds to determine which type of fund offers better performance. To conduct the analysis, a sample of four private and four public mutual funds was randomly selected, and their performance was evaluated using various performance metrics such as Sharpe ratio, Treynor ratio, and Jensen's alpha. The data was analyzed using statistical tools such as U test, t-test, and regression analysis. The study found that private sector mutual funds performed comparatively better than public sector mutual funds in terms of risk-adjusted returns, expense ratios, and asset allocation. Private sector mutual funds had higher Sharpe ratios and Treynor ratios compared to public sector mutual funds, indicating that they generated higher returns per unit of risk taken. Private sector mutual funds also had lower expense ratios, indicating that they charged lower fees to investors. In terms of asset allocation, private sector mutual funds had a higher allocation towards equity securities compared to public sector mutual funds, which had a higher allocation towards debt securities. The study also identified significant differences in the investment strategies, portfolio management, and investor base of private and public mutual funds. Private sector mutual funds had a more aggressive investment strategy, with a higher allocation towards equity securities, whereas public sector mutual funds had a more conservative investment strategy, with a higher allocation towards debt securities. Private sector mutual funds were also found to be more actively managed compared to public sector mutual funds. Private sector mutual funds had a higher percentage of assets under management from retail investors, while public sector mutual funds had a higher percentage of assets under management from institutional investors. The study provides valuable insights to investors, fund managers, and policymakers regarding the performance of private and public mutual funds. The findings suggest that investors may benefit from investing in private sector mutual funds due to their higher risk-adjusted returns, lower expense ratios, and higher allocation towards equity securities. Fund managers may also benefit from the study by gaining insights into the investment strategies and portfolio management practices of private and public mutual funds. Policymakers may use the study to design policies that promote the growth and development of the mutual fund industry. Overall, this study contributes to the existing literature on mutual funds by providing a comprehensive comparative analysis of private and public mutual funds in terms of their performance. The study adds to our understanding of the factors that affect the performance of mutual funds and provides insights into the investment strategies and portfolio management practices of private and public mutual funds.

CHANGES IN RESEARCH AND DEVELOPMENT DURING FINANCIAL DISTRESS: EMPIRICAL EVIDENCE FROM THE 2007–2008 FINANCIAL CRISIS

We examine how changes in research and development expenditures (R&Ds) at the beginning of the 2008 financial crisis affected firms’ market performance immediately after the crisis. Our sample contains 2470 firms listed on NYSE and NASDAQ. We find that firms that increased their investment in R&Ds had higher risk-adjusted returns in 2009. The highest risk-adjusted returns were among firms that decreased dividends but increased their R&Ds and are associated with the firms’ managerial efforts before and during the crisis. These findings underscore the importance of investment in innovations even during severe cash constraints and document that firms benefit from preserving cash by cutting other than R&D expenses.

Low Carbon Mutual Funds

Abstract Climate change poses new challenges for portfolio management. In our not-yet-low carbon world, investors face a trade-off between minimizing their exposure to climate risks and maximizing the benefits of portfolio diversification. This article investigates how investors and financial intermediaries navigate this trade-off. After the release of Morningstar’s novel carbon risk metrics in April 2018, mutual funds labeled as “low carbon” experienced a significant increase in investor demand, especially those with high risk-adjusted returns. Fund managers actively reduced their exposure to firms with high carbon risk scores, especially stocks with returns that correlated more with the funds’ portfolios and were thus less useful for diversification. These findings shed light on whether and how climate-related information can re-orient capital flows in a low carbon direction.

The dynamic role of the Japanese property sector REITs in mixed-assets portfolio

PurposeThis study examined the dynamic role of the Japanese property sector, particularly the real estate investment trusts (REITs), in mixed-asset portfolios of stocks and bonds, as well as office, retail, hotel and residential REITs.Design/methodology/approachDaily data were retrieved from 01 January 2008 to 31 December 2019. The sample time frame consisted of in-sample and out-of-sample periods. The dynamic conditional correlation-generalised autoregressive conditional heteroskedastic (DCC-GJRGARCH) model was deployed to obtain the forecast estimates of time-varying volatility of REITs and correlations with other assets. The estimates were employed to construct out-of-sample portfolios based on the three assets for daily investment. The five sets of portfolios with each individual property sector REITs, as well as a portfolio of stocks and bonds that served as a benchmark, were produced. The average utility for each set of portfolios was estimated and compared with the average utility of the benchmark portfolio. The average transaction cost (TC) for portfolio rebalancing was calculated as well.FindingsThe forecast of volatility estimates for each property sector revealed that each asset displayed a similar pattern with the differences in the volatility magnitude. Notably, hotel and retail REITs were more volatile than other property sector REITs. The property sector REITs exhibited a positive correlation with stocks but negatively linked with bonds. The results unveiled the diversification benefits of incorporating property sector REITs. The portfolio with property sector REITs had higher risk-adjusted returns and utility, compared to portfolio consisting of stocks and bonds. The benefits outweighed the TC for portfolio rebalancing.Practical implicationsThis study highlights the importance of quantifying the conditional time-varying volatility and correlations of the property sector REITs with other asset returns, especially for investment decision, to select and include property sector REITs in mixed-asset portfolios. For fund managers seeking liquid assets in daily investment, this analysis suggests the inclusion of hotel and retail REITs to enhance REITs' portfolio performance.Originality/valueThis study is the first to investigate the dynamic characteristics of the volatility and correlation of each property sector REITs with other financial assets by employing the conditional framework that accounted for short- and long-run persistency in economic shocks. The reported outcomes shed light on the differences in the underlying properties that contribute to the variances in dynamic volatility of each sector REITs, as well as REITs' correlations with stocks and bonds. This application enables the authors to transmit the dynamics of variance-covariance matrix amongst each property sector REITs, stocks and bonds into asset allocation problem on a daily basis.

A new class of Shariah-compliant portfolio optimization model: diversification analysis

<abstract><p>This study proposes a novel Shariah-compliant portfolio optimization model tested on the daily historical return of 154 Shariah-compliant securities reported by the Shariah Advisory Council of Securities Commission Malaysia from 2011 to 2020. The mathematical model employs an annual rebalancing strategy subject to a Conditional Value-at-Risk (CVaR) constraint while considering practical and Islamic trading concerns, including transaction costs, holding limits, and <italic>zakat</italic> payment. To validate the model, the optimal portfolios are compared against an Islamic benchmark index, a market index, and portfolios generated by the mean-variance model, as well as a forecast accuracy test by the Mean Absolute Percentage Error and Mean Absolute Arctangent Percentage Error. Furthermore, this study examines the inter-stock relationship within the generated portfolios using correlation and Granger causality tests to identify the diversification performance. Results show an outperformance of the model in offering portfolios with higher risk-adjusted returns under a comparably short computational time and an indication of generally well-diversified portfolios by the weak correlations between securities. The study further noted that the model is adept at risk management in addition to higher forecast accuracy during financial crises by showing remarkably fewer causal relationships during bear markets in 2011, 2014, and 2020. The findings of an inversed relationship between portfolio risk and the number of causalities between securities offer new insights into the effect of dynamic relationships between securities on portfolio diversification. In conclusion, the proposed model carries higher moral and social values than the conventional models while portraying high potential in enhancing the efficiency of asset allocation, contributing to economic diversification and the scarce literature on Islamic portfolio optimization modelling. The study also supports the substantially increasing demand for Shariah-compliant strategies following globalization and the changing demographic of the real financial world with growing priorities of social and sustainability values.</p></abstract>

The Impact of Covid-19 on the Performance of Hedge Funds Compared to Mutual Funds in South Africa

Investors are constantly searching for methods to generate value above passive investment techniques. Therefore, analysing the performance of hedge funds as compared to mutual funds, particularly in the wake of Covid-19, can aid investors in their investment decision-making process. Those investors who desire above-average returns, particularly in volatile market conditions place an expectation on hedge funds to be able to achieve higher performance during economic downturns, given that they are designed to mitigate risk and to take advantage of harsh financial market conditions. Monthly, secondary data were collected from 30 September 2018 to 31 August 2021 to analyse and compare the risk-adjusted performance of five hedge funds and five mutual funds in South Africa. Both hedge and mutual funds indicated higher risk-adjusted returns from the pre-Covid-19 period compared to during the pandemic. Hedge funds were found to have higher risk-adjusted returns than mutual funds during the Covid-19 period. The novelty of these results indicated that hedge fund managers can achieve higher returns for investors during extreme market events.

The Long-Term Capital-Market Performance of the Forestry Sector: An Investors’ Perspective

High risk-adjusted returns, low correlation with financial asset classes and inflation hedging are investment characteristics that make forests a desirable investment opportunity. To examine returns on forestry investments (from 2011 to 2020), we focused solely on 48 forest companies (across the globe) that were listed on stock exchanges. Results indicate the economic justification of investing in publicly traded forestry companies. The positive five-year beta coefficients (β) range from 0.21 to 3.46, amounting to 1.15 on average. Taking the last 10-year comparison of the world’s most common capital market benchmarks, the highest return was achieved by the S&P500 (13.8% on average) followed by forestry companies (9.1%), U.S. Treasury bonds (4.4%), and gold (3.0%). Forestry companies, along with their associated business activities (sawmilling, final products production, and paper production), show the best historical performance from an investor’s point of view (total return of 13.2%).

Black-Litterman model with copula-based views in mean-CVaR portfolio optimization framework with weight constraints

This study examines the portfolio optimization problem by exploiting daily data of 10 international Exchange Trade Funds (ETF) from 2012 to 2022. We extend the Black-Litterman (BL) approach using ARMA-GARCH-copula-based expected returns as a proxy for investor views and use the CVaR metric as a risk measure in the optimization procedure. The BL approach provides a Bayesian methodology for combining the equilibrium returns and the investor views to produce expected returns. We use Regular Vine (R-vine) copula since it provides a flexible multivariate dependency modeling. The suggested approach is compared against the copula-CVaR portfolio, which likewise a BL copula approach avoids excessive corner solutions that many optimization approaches would generate in case of extreme values of estimated parameters. We compare the performance of these two approaches using out-of-sample back-testing against two benchmarks: Mean–Variance optimizations (MV) and equal weights portfolio (EW). To further reduce the sensitivity of considered strategies to input parameters, we evaluate out-of-sample performance at three levels of maximum weight constraints: 30%, 40%, and 50%. Moreover, in this paper, we consider different levels of view confidence—τ in the Black-Litterman model as it significantly affects the obtained results and inferences. We calculate and report the portfolios’ tail risks, maximum drawdown, turnover, and the break-even point for all optimization approaches. Our empirical analysis indicates better performance for the CBL portfolio regarding lower tail risk and higher risk-adjusted returns, and the copula-CVaR portfolio is better regarding lower turnover and higher break-even point.

Active mutual funds: Beware of smart beta ETFs!

Smart beta ETFs have gained tremendous prevalence among investors in recent years. This study provides empirical evidence that a proportion of this fast-paced growth can be attributed to the investor migration from closet factor active mutual funds to smart beta ETFs. Using a sample of US domestic equity active mutual funds and smart beta ETFs from 2000 to 2019, we find that smart beta ETFs offer factor exposures at lower fees and therefore higher risk-adjusted returns than closet factor funds. The investors notice the benefits of smart beta ETFs and replace closet factor funds with these ETFs. Closet factor funds are at higher risks of being replaced when investors are sophisticated, when the market share of smart beta ETFs increases, and after 2012. Our findings illustrate the dynamic changes in investor preference towards investment products that bring similar or greater benefits at a lower price.

Information in financial markets: Who gets it first?

I compare the timing of information acquisition among institutional investors and sell-side analysts. I find that hedge funds are unique: they anticipate analyst reports, and then reverse their positions after analysts publish reports. These trends are strongest for hedge funds and analysts most closely geographically situated. I also find that hedge funds generate their highest risk-adjusted returns among stocks with high analyst coverage. These results indicate that hedge funds are faster relative to analysts and other investors, and suggest that analysts assist hedge funds in exploiting their information acquisition advantages.

Isolating momentum crashes

Across markets, momentum is one of the most prominent anomalies and leads to high risk-adjusted returns. On the downside, momentum exhibits huge tail risk as there are short but persistent periods of highly negative returns. Crashes occur in rebounding bear markets, when momentum displays negative betas and momentum volatility is high. Based on ex-ante calculations of these risk measures we construct a crash indicator that effectively isolates momentum crashes from momentum bull markets. An implementable trading strategy that combines both systematic and momentum-specific risk more than doubles the Sharpe ratio of original momentum and outperforms existing risk management strategies over the 1928–2020 period, in 5 and 10-year sub-samples, and an international momentum portfolio.

Do Ethical Companies Have High Stock Prices or High Returns?

In this paper, we examine the performance of an impact investing strategy using the most ethical companies to build an impact investing portfolio. We test the time-series and cross-sectional returns of the impact portfolio, explore the financial analyst coverage of the most ethical firms, and run regressions to analyze the valuation of the most ethical firms. Our empirical results reveal that the portfolio consisting of the most ethical firms has a higher risk-adjusted return and that the most ethical firms have lower stock valuations than comparable stocks. We attribute our findings to the incomplete information in business ethics norms.

Design and Evaluation of Robo-Advisors Using Index Fund and Alternative Assets of Cryptocurrency and Gold: Case of Indonesian Capital Market

Robo-advisor is one of the most prominent innovation in the wealth management industry, and its success in Indonesia has been evident in the case of Bibit. Therefore, wealth management companies need to employ Robo-Advisor to overcome their competition. This research aims to give recommendation on asset allocation method and asset class selection for Robo-Advisors in Indonesia using Sharpe Ratio Analysis. Then, the author will analyze the robo-advisor’s performance during equity market downturn. Finally, The Robo-Advisor’s actual performance will be tested in 2018, 2019, and 2020. The Sharpe ratio analysis result showed that Robo-Advisors seeking higher risk-adjusted return should choose mean-variance optimization over risk parity for asset allocation method, and the inclusion of gold and bitcoin in a portfolio of stock mutual fund and bond mutual fund increases the risk-adjusted return of the portfolio. The proposed robo-advisor’s portfolio protected investors from equity market downturn in 2011-2010 in 83,3% of the case. Finally, the proposed robo-advisor’s portfolio generated better return for the conservative, moderate and aggressive investor during 2018, 2019, and 2020 when compared to LQ45.

Low-risk investment strategy: sector bets or stock bets?

PurposeThe portfolio of low-risk stocks outperforms the portfolio of high-risk stocks and market portfolios on a risk-adjusted basis. This phenomenon is called the low-risk effect. There are several economic and behavioral explanations for the existence and persistence of such an effect. However, it is still unclear whether specific sector orientation drives the low-risk effect. The study seeks to answer the following important questions in Indian equity markets: (a) Whether sector bets or stock bets mainly drive the low-risk effect? (b) Is it a mere proxy for the well-known value effect? (c) Does the low-risk effect prevail in long-only portfolios?Design/methodology/approachThe study is based on all the listed stocks on the National Stock Exchange (NSE) of India from December 1994 to September 2018. It classifies them into 11 Global Industry Classification Standard (GICS) sectors to construct stock-level and sector-level BAB (Betting Against Beta) and long-only low-risk portfolios. It follows the study of Asness et al. (2014) to construct various BAB portfolios. It applies Fama–French (FF) three-factor and Fama–French–Carhart (FFC) four-factor asset pricing models in addition to Capital Asset Pricing Model (CAPM) to examine the strength of BAB, sector-level BAB, stock-level BAB and long-only low-beta portfolios.FindingsBoth sector- and stock-level bets contribute to the return of the low-risk investing strategy, but the stock-level effect is dominant. Only betting on safe sectors or industries will not earn economically significant alpha. The low-risk effect is unique and not a value effect in disguise. Both long-short and long-only portfolios within sectors and industry groups deliver positive excess returns. Consumer staples, financial, materials and healthcare sectors mainly contribute to the returns of the low-risk effect in India. This study offers empirical evidence against the Samuelson (1998) micro-efficient market given the strong performance of the stock-level low-risk effect.Practical implicationsThe superior performance of the low-risk investment strategies at both stock and sector levels offers investors an opportunity to strategically invest in stocks from the right sectors and earn high risk-adjusted returns with lower drawdowns over an entire market cycle. Besides, it paves the way for stock exchanges and index manufacturers to launch sector-specific low-volatility indices for relevant sectors. Passive funds can launch index funds and exchange-traded funds by tracking these indices. Active fund managers can espouse sector-specific low-risk investment strategies based on the results of this and similar other studies.Originality/valueThe study is the first of its kind. It offers insights into the portfolio characteristics and performance of the long-short and the long-only variant of low-risk portfolios within sectors and industry groups. It decomposes the low-risk effect into sector-level and stock-level effects.

Institutional timberland investment in South and Central America

In this paper I investigate the origins, trend, and drivers of institutional timberland investment in South and Central America. I note that domestic institutions in South America are a distinctive source of, and a significant contributor to, the rise of institutional timberland investment in the world in the last six-plus decades. I further show that foreign institutions have increased their timberland investment in the region since the 1990s, motivated by seeking high risk-adjusted returns. Finally, I explain this trend and the per-acre timberland value in South and Central America.

Does performance persistence exist in mutual and pension funds? Evidence from Turkey

The objective of this study is to investigate the performance persistence of Turkish mutual and pension funds. 310 mutual and 259 pension funds were analyzed between the period of 2010–2019 in order to determine if there is an evidence of performance persistence. In this study, a persistence rate is developed, and the skill ratio is used to crosscheck the results of the persistence rate. Furthermore, six different risk-adjusted return measures, such as Sharpe, Treynor, Information, Jensen’s alpha, Sortino, and Omega ratios are calculated to analyze whether funds also exhibit superior risk-adjusted returns. The results indicate that only 2% of funds demonstrate persistence above 50%, and 15 out of 20 fund categories do not have any funds that show persistence in 10 years. Most of the persistent funds have positive skill ratios, and it is observed that the persistence rate is effective. However, it cannot be stated that there is performance persistence in the Turkish fund management industry, since performance persistence is not evident for various fund types, so investors do not need to invest in the best funds of the previous year. Additionally, the empirical results associated with risk-adjusted performance analysis indicate that persistent funds also do not generally yield higher risk-adjusted returns. The lack of persistence in funds’ performance is a significant result for investors in their investment decisions, for fund managers in their human resource policies and bonus schemes, and for regulators in their policy decisions.

Green investments: A luxury good or a financial necessity?

This study examines the diversification and hedging benefits of green investments for conventional stock portfolios in the context of the recent COVID-19 pandemic. While the findings confirm the status of gold as a strong hedge against stock market downturns, we find that clean energy investments, green bonds, in particular, have the potential to serve as a safe haven as well. In fact, compared to the other alternative and sustainable investments in our sample, green bonds are found to be the only asset that serves as a safe haven against large stock market fluctuations due to the COVID-19 pandemic. Portfolio analysis further shows that supplementing conventional stock portfolios with green bonds during the COVID-19 pandemic resulted in the highest risk-adjusted returns, compared to those supplemented with other alternative assets in the sample. Our findings support the emergence of green investments not as a luxury good, but a necessity for improved financial stability and performance, particularly during the turbulent market states driven by the recent pandemic.