Longer Investment Horizons Research Articles

Bull and bear markets during the COVID-19 pandemic

The COVID-19 pandemic has caused severe disruption worldwide. We analyze the aggregate U.S. stock market during this period, including implications for both short and long-horizon investors. We identify bull and bear market regimes including their bull correction and bear rally components, demonstrate our model’s performance in capturing periods of significant regime change, and provide weekly forecasts that improve risk management and investment decisions. An investment strategy that uses out-of-sample forecasts for market states outperforms a buy and hold strategy during the pandemic by a wide margin, both in terms of annualized returns and Sharpe ratios.

The Norway Model in Perspective

The authors’ 2012 article on the Norway model spotlighted that country’s sovereign wealth fund. They argued that Norway provides a coherent and compelling approach to managing long-term pools of assets. Since then, the Norwegian Government Pension Fund has grown in scale and complexity, and its structure has evolved. Meanwhile, other models for asset management have been put forward. In this article, the authors review Norway’s investment strategy in the light of the last decade’s experience, put it in a broader context by comparing Norway with alternative approaches, and reexamine the fund’s commitment to responsible investing. Since the authors wrote their earlier paper, environmental and social issues have come to the fore, and there is still much to learn from the Norway model. <b>TOPICS:</b>Foundations &amp; endowments, portfolio theory, portfolio construction, ESG investing <b>Key Findings</b> ▪ Today the Norwegian Government Pension Fund is the world’s largest sovereign wealth fund. It remains a model for long-horizon investors, including those of more modest size. ▪ Norway has considerable freedom in how to invest its assets. It is an asset allocator, not a liability matcher. ▪ Norway is cost conscious and emphasizes transparency, and this influences its strategy. Other investors favor private assets and may prefer different approaches, such as the Yale model or the Canada model. ▪ The fund provides a model for financial investors who wish to be known for transparency and clarity of governance, low management costs, high liquidity, and high standards of ethical behavior.

Owner offspring gender and long‐term resource allocation in Chinese family firms

AbstractA long‐term orientation helps companies improve business performance and achieve sustainable competitive advantages. We use data for Chinese family firms listed on the Shanghai and Shenzhen A‐share stock markets during the years 2000 and 2018. We examine the influence of owner offspring gender on family firms' long‐term resource allocation. We find a “son effect” in long‐term resource allocation among family firms, that is, owners raising sons tend to have a longer investment horizon and are more willing to increase innovation. This “son effect” is more significant for owners who were born in patriarchal regions where the social system is controlled or governed by men. We also find that son‐raising owners' long‐term resource allocation is mainly motivated by their willingness of intergenerational inheritance. This study fills a research gap regarding the influence of owner offspring gender on corporate long‐term resource allocation, enriches the literature on the heterogeneity of executive behavior and corporate governance of family firms, and provides important implications for understanding the decision making and long‐term investments of Chinese family firms.

Factor-Investing and Asset Allocation Strategies: A Comparison of Factor Versus Sector Optimization

Given the tremendous growth of factor allocation strategies in active and passive fund management, we investigate whether either asset allocation strategies based on factors or sectors provide investors with a superior portfolio performance. Our focus is on comparing factor versus sector allocation as some recent empirical evidence indicates the dominance of sector over country portfolios. We analyze the performance and performance differences of sector and factor portfolios for various weighting and portfolio optimization approaches including ‘equal-weighting’ (1/N), ‘risk-parity’ (RP), minimum-variance (MinVar), mean-variance (MV), Bayes-Stein (BS) and Black-Litterman (BL) by employing a sample-based approach in which the sample moments are the input parameters for the allocation model. For the period from May 2007 to November 2020, our results clearly reveal that, over longer investment horizons, factor portfolios provide relative superior performances. For shorter periods, however, we observe time varying and alternating performance dominances as the relative advantage of one over the other strategy depends on the economic cycle. We find that during “normal” times factor portfolios clearly dominate sector portfolios, whereas during crisis periods sector portfolios are superior offering better diversification opportunities.

Are ESG Funds More Transparent?

I explore whether managers of Environmental, Social, and Governance (ESG) funds differ in their disclosure behavior vis-a-vis conventional fund managers. Consistent with ESG fund investors having longer investment horizons, I find that ESG portfolio managers engage in less opportunistic disclosure activities than their conventional fund managers counterparts. Interestingly, managers of ESG and conventional funds have similar portfolio turnovers, despite the conventional wisdom that ESG investors are more long-term oriented. Notably, I find no evidence that investment management firms endogenously assign portfolio managers to ESG and conventional funds based on managers’ characteristics. Overall, my results suggest that the preferences of ESG investors affect ESG managers' willingness to engage in opportunistic trading without significantly affecting their real portfolio decisions.

Managing Political Risk in International Portfolios

We show that internationally diversified portfolios carry sizeable political risk premia. Using a portfolio selection model with tail risk, we obtain political efficient frontiers from skewed return distributions to manage political risk, and design an inference test to draw conclusions. We find that politically hedged international portfolios of US investors realize performance gains against a broad market index (and other benchmarks). Currency hedging does not eliminate political risk. The diversification gains increase for long-horizon investors. Qualitatively identical results are obtained for Eurozone and Japan. Our findings inform the home equity bias puzzle literature, and are robust to several model specifications.

Taking a gamble: Chinese overseas energy finance and country risk

Investment in renewable energy is essential for reaching ambitious climate goals outlined in the Paris Agreement. Unfortunately, a large investment gap prevails, particularly in developing economies with underdeveloped domestic capital markets and weak institutions. Multilateral development banks with softer budget constraints and longer investment horizons can play an important role in filling this gap. Development finance, which traditionally originated in the West, has been increasingly dominated by two Chinese state-owned development banks: the China Development Bank and the China Export-Import Bank. These banks acted as major financiers of the Chinese Belt and Road Initiative and, between 2005 and 2017, provided more than US$220 billion of overseas energy finance - more than any other multilateral development bank. Their investments have been controversial: the Chinese banks were often accused of financing fossil fuels projects located in politically and economically risky countries. This paper uses detailed data on the Chinese energy finance to illustrate the investment pattern of the Chinese banks, and implements Hurdle and simultaneous Probit models to test whether the two banks are in fact tolerant of the country risk: credit, governance and political risk. The analysis shows that projects located in countries that are politically stable but have higher credit risk and corruption levels are more likely to receive Chinese energy finance. Governance risk and autocratic regime type do not affect the decisions of the Chinese banks. This investment pattern indicates missed opportunities for advancing the clean energy transition and creates future risks for the host countries i.e. stranded assets.

Insurer risk and performance before, during, and after the 2008 financial crisis: The role of monitoring institutional ownership

AbstractThis study examines the relationship between institutional ownership and insurers' risk and performance before, during, and after the 2008 financial crisis. Monitoring institutional investors are defined as those that have (a) a long‐term investment horizon, (b) large holdings in the investee firm, (c) independence from management, and (d) a large portion of their portfolio invested in the firm. We measure both the level and persistence of monitoring institutional ownership and find a negative relationship between monitoring institutional ownership and an insurer's stock stability and performance during the crisis. Further examination reveals that these firms took more risk before the crisis. Whereas many monitoring institutions exited the insurance market after the crisis, evidence suggests that the remaining institutional investors in the postcrisis period have a longer investment horizon and are active in monitoring and risk management.

Deep Learning, Predictability, and Optimal Portfolio Returns

We study dynamic portfolio choice of a long-horizon investor who uses deep learning methods to predict equity returns when forming optimal portfolios. Our results show statistically and economically significant benefits from using deep learning to form optimal portfolios through certainty equivalent returns and Sharpe ratios. Return predictability via deep learning also generates substantially improved portfolio performance across different subsamples, particularly during recessionary periods. These gains are robust to including transaction costs, short-selling and borrowing constraints.

Investing for the long run when expected equity premium is nonnegative

Barberis (2000) demonstrates that estimation risk plays an important role in long-run asset allocation. After incorporating estimation risk, he finds that predictability in returns makes investors allocate substantially more to stocks in the long run than in the short run. We show that, when the nonnegative equity premium (NEP) condition is imposed on predictive regressions, investors actually allocate roughly the same or less to stocks in the long run. The reason is that the NEP reduces mean reversion in returns by providing informative prior beliefs. A long-horizon investor who ignores reduction in mean reversion may overallocate to stocks by a sizeable amount.

Manager Characteristics and Hedge Fund Returns, Liquidity, and Survival

Existing empirical studies assert that there is significant cross-sectional variation in the risk-adjusted returns of hedge funds, and that their performance is affected by manager characteristics such as education. However, when analyzing the impact of manager characteristics, prior research does not control for the difference in liquidity. In this study we find that manager education affects the liquidity of hedge fund shares and assets; on average, managers educated in elite institutions impose stronger share restrictions and thus can better manage illiquid assets to generate a liquidity premium. We also find that manager education affects the survival of hedge funds, but that the CFA designation has a stronger impact. From 1994 to 2015, the hazard rate of CFA funds was 13.6% lower, and the difference was significant after controlling for risk, return, and investment style effects. Our findings are important because the search and due diligence process is costly for investors such as pension funds—and survival rates reduce costs. TOPICS:Performance measurement, manager selection, style investing Key Findings • Manager characteristics such as education affect the liquidity of hedge fund shares and assets. On average, hedge funds whose managers were educated in elite institutions imposed stronger share restrictions and invested in more illiquid assets than other funds did. • Share restrictions enable funds to better manage illiquid assets, and the skills and alumni networks of managers contribute to this advantage. This article shows that the major driving force is trust inspired by the reputation and network of elite institutions. • The educational backgrounds and certification of hedge fund managers are related not only to the liquidity premium that long-horizon investors can earn, but also to the lower search costs due to the higher survival rates.

Institutional investors' horizons and corporate employment decisions

Monitoring by long-term investors should reduce agency conflicts in firms' labor investment choices. Consistent with this argument, we find that abnormal net hiring, measured as the absolute deviation from optimal net hiring predicted by economic fundamentals, decreases in the presence of institutional investors with longer investment horizons. Firms dominated by long-term shareholders reduce both over-investment (over-hiring and under-firing) and under-investment (under-hiring) in employees. The monitoring role of long-term investors is stronger for firms facing higher labor adjustment costs both in absolute terms and relative to capital adjustment costs, and those for which human capital is regarded as more important. The effect is also more pronounced for firms that have stronger incentives and/or more opportunities to deviate from expected net hiring. We address endogeneity concerns by exploiting exogenous changes to long-term institutional ownership resulting from annual reconstitutions of the Russell indexes.

Can Long-Term Institutional Owners Improve Market Efficiency in Parsing Complex Legal Disputes?

Long-horizon institutional investors can help mitigate information asymmetries around securities class action (SCA) lawsuits. We find that the machine readability of SCA complaint filings can predict the outcome and duration of class actions. Long-term institutional investor ownership leads to a more positive post-SCA announcement price reaction and increases the volatility ratio of prices as a measure of price informativeness. Furthermore, there is a significant interaction effect between long-term institutional ownership and SCA complexity on price informativeness consistent with a superior information processing ability about complex corporate events affecting portfolio firms.

Perusahaan Keluarga, Koneksi Politik &amp; Kinerja Perusahaan

Family businesses dominate the private sector in Indonesia and contribute 13.4% of the country's GDP. The family company has a longer investment horizon than the shareholders because the founder wants to continue bequeath the company to subsequent generations. To achieve these objectives the company will try to overcome the company's external constraints. The trick is through political connections. With a political connection the company will get various benefits so that it will ultimately contribute to the company's performance. This paper is a literature review of family businesses and political connections. Based on the results of the study, the researchers concluded that the family company had better performance than the non-family company. Politically connected companies have better performance than companies that are not politically connected during the reign of politicians concerned. Politically connected family companies have better performance than politically connected family companies.

Bull and Bear Markets During the COVID-19 Pandemic

The COVID-19 pandemic has caused severe disruption to economic activity worldwide. This note analyzes what happened to the aggregate U.S. stock market during this period, including implications for both short and long-horizon investors. We identify bull and bear market regimes including their bull correction and bear rally components, demonstrate our model's performance in capturing periods of significant regime change, and provide both weekly and long-horizon forecasts that improve risk management and investment decisions. Using out-of-sample forecasts for market states to guide an investment strategy, outperforms a buy and hold strategy during the pandemic by a wide margin, both in terms of annualized returns and Sharpe ratios.

Insider trading and shareholder investment horizons

This paper examines the effects of shareholder investment horizons on insider trading. We find that insiders are less likely to trade on private information and the profitability of insider trades is lower when shareholder investment horizons are longer. We further examine two channels through which shareholders with longer investment horizons can impede insider trading: direct monitoring and better information environment. Consistent with the direct monitoring channel, we show that insiders in firms with longer shareholder investment horizons are more likely to shift trades from the month right before earnings announcements to the month right after earnings announcements. Moreover, the impact of investment horizons are stronger in firms with higher ex ante litigation risk, with lower corporate governance quality, and that are not targets of hedge fund activists. Consistent with the information environment channel, we show that longer shareholder investment horizons increase the frequencies of information disclosure and insiders in firms with longer shareholder investment horizons are more likely to trade in an isolated manner rather than in sequences.

Capturing volatility persistence: a dynamically complete realized EGARCH-MIDAS model

We introduce extensions of the Realized Exponential GARCH model (REGARCH) that capture the evident high persistence typically observed in measures of financial market volatility in a tractable fashion. The extensions decompose conditional variance into a short-term and a long-term component. The latter utilizes mixed-data sampling or a heterogeneous autoregressive structure, avoiding parameter proliferation otherwise incurred by using the classical ARMA structures embedded in the REGARCH. The proposed models are dynamically complete, facilitating multi-period forecasting. A thorough empirical investigation with an exchange-traded fund that tracks the S&P500 Index and 20 individual stocks shows that our models better capture the dependency structure of volatility. This leads to substantial improvements in empirical fit and predictive ability at both short and long horizons relative to the original REGARCH. A volatility-timing trading strategy shows that capturing volatility persistence yields substantial utility gains for a mean–variance investor at longer investment horizons.

Private and Public Real Estate - What's the Link? (May 2010)

In this paper, we study the relationship between private and public real estate in the US and UK markets. We demonstrate a strong link between public and private real estate returns in each of these markets. To uncover these relationships, we correct for appraisal smoothing and properly account for the lead-lag relationship between public and private returns. We find that public returns lead private returns, even after removing appraisal smoothing in private returns. We also discuss how real estate risk changes over longer horizons. In particular, our results suggest that private and public returns become more correlated at longer investment horizons. This carries important implications for risk management and strategic asset allocation.

Investment Horizon and the Choice of Mutual Fund

The purpose of this study is to explore the relationship between the choice of mutual fund investment style and investor investment horizon. The investment style is characterized as a measure of the riskiness of the mutual fund and therefore the required/expected return of a mutual fund ranging from large cap value to small cap growth. The results of this study show that investment horizon and investment style are inter-related. Longer investment horizons are best suited for small cap value and small cap growth. In general, for each investment horizon, the large cap value style had the lowest expected return as evidenced by its beta coefficient. The investment style with the highest expected return depends on the investment horizon.

Do long-term institutional investors promote corporate social responsibility activities?

Abstract This paper examines how the investment horizons of a firm's institutional investors affect its corporate social responsibility (CSR) activities. Using data on U.S. firms’ CSR ratings over the 1995–2012 period, we find that longer investment horizons are positively related to CSR. Further, active long-term institutions increase CSR whereas passive long-term institutions have no significant effect. Our results suggest that investors with long-term horizons have more incentives to monitor their firms which leads managers to engage in more vigorous CSR activities.