Institutional Portfolios Research Articles

Distinguishing True Alpha from Beta

Portfolios can be thought of as being composed of a beta component, which is broad asset class exposure, and an alpha component, which is excess return achieved through active management. If investors are hiring active managers, presumably because they believe these managers have real skill or the ability to deliver alpha, then they ought to be sure that they are paying for true alpha and not beta. These principles are not only applicable to traditional institutional portfolios, such as defined-benefit plans and endowments, but are also relevant for nontraditional portfolios, such as hedge funds.

Housing investment in an institutional portfolio context

Residential property in a multi‐asset portfolio context has been considered from two substantially different perspectives: institutional investor's and the household's perspective. This paper constitutes the first of two related surveys on the role of residential property in a multi‐asset portfolio. The paper provides an introduction to housing property investment at a macro level and reviews the main empirical issues related to housing investment in an institutional portfolio context. The literature in this regard generally supports the evidence that residential property is a more effective hedge against inflation than both shares and bonds. Additionally, the reviewed studies generally report that unsecuritised housing investment not only generates risk‐adjusted returns comparable to those of bonds and shares, but also exhibits low levels of correlation with classic asset groups of institutional portfolios.

Short-sellers: The neglected breed

This paper shows that the short-sellers classification can shield a traditional investment portfolio against broad stock market declines. During the bull market of the 1990s the short-sellers strategy was crushed and a handful of remaining surviving funds managed to weather the storm. Short-sellers re-emerged at the start of the new millennium and have performed well compared to stock and bond market indices as well as to other hedge fund strategies. The conclusion is that the short-sellers strategy is a necessity in pension fund and institutional portfolios to protect investors from declining markets and should not be neglected.

The Impact of Globalization on the Equity Cost of Capital

The advent of the single currency within the European Union provides a natural experiment to measure how the cost of equity changes as globalization takes place. This is because the launch of the single currency has led to the elimination of currency-related restrictions on the composition of institutional investors' portfolios and, hence, to increased risk sharing among EU investors. We focus not only on the impact of globalization on the level of the cost of equity, but also on the cross-country and cross-sectoral dispersion in the cost of capital. Over the 1990s it is shown that the cost of equity within EU sectors falls by between 0.5 and 3 percentage points. There is strong evidence of convergence in the cost of equity across different countries in the same sector. Convergence across different sectors is small. An implication for portfolio management is that country effects are becoming smaller and sector effects larger.

On the Role of Hedge Funds in Institutional Portfolios

Hedge funds do not easily fit into the current way institutions go about investing. Based on a survey of recent academic and practitioner research, the author reviews six competing frameworks for how to incorporate hedge funds in institutional portfolios. Each framework has very different implications for institutional asset allocation, manager selection, and benchmarking.

Real Estate in the Institutional Portfolio

The main objective of this study is to provide international evidence on the discrepancy between suggested and actual allocations to real estate in institutional portfolios, and also to discuss possible reasons for the discrepancy. We use data for the U.S., U.K., Sweden, and Switzerland to investigate the benefits of including real estate assets? both domestic and international? in institutional portfolios. The optimal allocation to real estate is found to be 15% to 20%, and is remarkably stable across countries. The suggested allocations to real estate in institutional portfolios are then compared with the actual institutional holdings in these four countries. The latter are found to be much less than the former, and some possible explanations for the discrepancy are given. The study also reports a substantial home bias in institutional real estate portfolios.

The impact of the euro on Europe's financial markets

This paper presents an overview of the impact of the introduction of the euro on Europe's financial structure over the first four years since the start of EMU. It analyzes changes in money markets, bond markets, equity markets and foreign exchange markets. Euro's role in originating or catalyzing trends has been uneven across the spectrum of financial markets. From the supply side, banks and investors in fixed income markets have become more focused on the characteristics of individual borrowers rather than the nationality of the issuer and have built up expertise to evaluate credit risk. European equity markets have also been affected by the enhanced ability of investors to build strategies with a pan‐European perspective as prices increasingly reflected risk factors specific to industrial sectors rather than individual countries. On the borrower side, EMU has increased the attractiveness of market‐based financing methods by allowing debt issuers to tap institutional portfolios across the euro area. Lower barriers to cross‐border financial transactions have also increased the contestability of the market for financial services, be it at the wholesale or the retail level.The introduction of the euro has also highlighted the shortcomings of existing institutional structures and areas where excessive focus on narrowly defined interests may stand in the way of realizing the full potential benefits from the new environment. Diverging legal and institutional infrastructures and market practices can impede further financial market development and deepening. Hence, the euro has put a premium on cooperation between national authorities and institution as a means of achieving a more harmonized financial environment.The impact of EMU on depth in foreign exchange markets has been less clear‐cut, as volatility, spreads, trading volumes and liquidity appear not to have changed in a substantial way. Overall, it seems that the new currency has made some progress towards the goal of becoming a currency of international stature that would rival that of the US dollar. However, a number of the necessary next steps towards achieving this goal are also among the trickiest to implement.

Adding Exchange-Traded Funds to the Institutional Portfolio Mix

This article addresses the following key points: ETFs can fit into active strategies as well as passive ones. ETFs allow targeted exposures to sectors and markets. ETFs can provide an alternative to futures as a transition tool. Fixed-income ETFs offer more transparent pricing information than typical bond trades.

Regional Investment Allocations in a Global Timber Market

With timberland increasingly being considered for inclusion in institutional portfolios due to its diversification potential, sophisticated investors need a reliable methodology by which to evaluate a proper timber portfolio. Evaluating the true investment characteristics of the asset class has historically been difficult due to infrequent valuations. Globalization of the timber industry has also accelerated in recent years, creating a need for an allocation methodology that can encompass timber regions outside of the United States. In this article, an approach is described in which the authors evaluate the true risks and correlation measures for a number of global timber regions, leading to an example of how an appropriate allocation policy can be tailored for investor-specific requirements.

Benefits of Real Estate Investment

Real estate investment represents a significant part of many institutional portfolios. Since real estate is not directly traded on a centralized exchange, the physical real estate market is characterized by relative lack of liquidity, large lot size, and high transactions costs with properties that are fixed at a location and heterogeneous. The low transparency of the real estate marketplace also results in potential asymmetric information. This provides a source of relatively high risk-adjusted returns to those individuals who can obtain costless “;quality” information. Furthermore, the lack of frequent transaction data for the analysis of return distributions often necessitates the use of appraisal-based series. In this article, the authors examine the benefits of real estate investments as part of an investor9s overall asset portfolio.

Investment Policy for Securitized and Direct Real Estate

In this article the author examines the constant and variable liquidity direct real estate price indexes developed by Fisher, Gatzlaff, Geltner, and Haurin and uses them in asset allocation exercises. Review of these indexes suggests they provide improved measures of direct real estate performance that do much to remedy problems resulting from the appraisal-induced smoothing of the NCREIF property index. Optimization results based on the period from 1987 to 2001 indicate that significant overweighting of both direct and securitized real estate was appropriate and that direct and securitized real estate were complementary investments. These results and related considerations suggest that real estate should receive at least a neutral weighting in contemporary institutional portfolios.

The Environment and Performance of Real Estate Investment Trusts

Executive Summary. Researchers have been interested in investigating the role of Real Estate Investment Trusts (REITs) in institutional portfolios since their debut in the financial market over four decades ago. The cyclical popularity and performance of various types of REITs as well as the availability of daily returns data for REITs have provided researchers a fruitful and unique area of examination. This study explores the recent financial economics literature on the environment and performance of REITs by extending the 1995 work of Corgel, McIntosh and Ott.

REITs in the decentralized investment industry

Existing studies provide conflicting results regarding whether real estate investment trusts (REITs) effectively optimize and diversify institutional portfolios. Based on the style analysis of Sharpe, we extend Liang and McIntosh’s study with a more complete set of asset classes over a longer sample period. We provide additional evidence suggesting that practicing analysts should include REITs as an asset class to optimize their portfolios. Specifically, our results show that the price behavior of REITs is unique and cannot be satisfactorily duplicated by combining equity, fixed‐income securities, and unsecuritized real estate. The time series of the styles on REITs indicates that it is difficult to ex ante produce returns on REITs without diversifying into REITs.

Clinical science: time for a new contract

Academic clinical medicine is widely believed to be in crisis. In particular patient-orientated research is notable for its almost complete absence from the research portfolios of many institutions. A number of recent reports have suggested ways to improve recruitment into clinical academic medicine. Here I argue that, in addition, we should realise that any such crisis is not just confined to medicine but affects most of the university sector. In medicine the situation is compounded by, first, our inability to recognise how much clinical advance occurs and, second, by a refusal to acknowledge the changing organisation and sociology of science. If academic medicine is to continue to be attractive to the brightest and most interesting minds institutional change is unavoidable.

Brand Perceptions and the Market for Common Stock

This paper investigates the effect of company brand perceptions on investor incentives to hold stocks. We find that, after controlling for other postulated determinants of stockholdings, there is a negative and significant cross-sectional relation between percentage institutional holdings and brand visibility. This result is consistent with the notion that individual investors prefer to invest in stocks with easily-recognized products. Furthermore, we find that institutional holdings are positively related to firm size and beta. These results are intertemporally stable. Our analysis supports the notion that institutional portfolios eschew the relatively neglected small firm sector, whereas individual investors prefer holding stocks with high recognition and consequently, greater information flows and smaller parameter estimation risk. The analysis contributes to our understanding of how investors form their equity portfolios.

Research priorities for alcoholism treatment.

The goals of the current NIAAA review process were to assess the breath, coverage, and balance of the treatment research portfolio and to identify areas for increased attention. Both alcoholism treatment experts and non-alcohol-related treatment experts were called upon to help with this task. Our group was encouraged by the fact that results from previous reviews have effectively been incorporated into the institute portfolio, particularly in the areas of the pharmacotherapy and psychotherapy development programs. The present review identified the five priority areas: mechanisms of action of treatment, combination and sequencing of treatments, health-seeking patterns and processes, concurrent disorders, and understanding help agent behaviors. In addition, several methodological and/or conceptual issues emerged that it was felt, crosscut these areas. These issues included greater emphasis on intervention testing in special populations, patient-treatment matching, measurement techniques, and technology transfer. Finally, several mechanisms of funding were outlined, including across-institute initiatives that could facilitate larger scale translational work such as comorbidity studies and/or studies of combined treatments. All the above were deemed important by the advisory committee, but an overarching emphasis was placed on understanding the mechanisms of action of treatment. For example, it is important to know that a particular pharmacotherapy reduces craving and also how this comes about. Similarly, it is key to the continued refinement of psychosocial treatments that the active components and their mechanisms of change be clarified. Such mechanism studies are crucial for the development of more heuristic and more accurate theoretical formulations that must guide our understanding of alcohol dependence if treatment, relapse, and recovery are to become more scientifically grounded.

The Benefits of Index Option-Based Strategies for Institutional Portfolios

This study reviews the potential benefit of index option-based strategies as well as the unique risk and return distributions that result from these strategies. The empirical results are based on the replication of passive option-based strategies using daily option data collected over the past thirteen years. These passive benchmarks are then compared to the performance of a number of active managers. The results indicate that many passive investment strategies offered risk-adjusted returns that exceeded the underlying index over the time period studied. Furthermore, the returns to these passive option-based strategies provide useful benchmarks for the performance of the active managers studied. Results presented here demonstrate that the source of this additional return can be identified and explained by combining a passive stock index investment with a passively managed option portfolio. This is important because it demonstrates that the returns achieved by actively managed strategies are not necessarily dependent on the unique skills of the managers.

Public Accountability and Reporting: What Should Be the Public Part of Accreditation?

AbstractElectronic institutional portfolios provide access to information on student learning outcomes and institutional accountability and thus respond to the public nature of information for accreditation. These portfolios are the focus of this chapter, discussed in the context of a national project involving six urban universities.

Transaction Costs

With rising turnover in institutional portfolios, investment managers are paying increasing attention to transaction costs. The authors provide some insight into managing costs in an approach that assumes trading is a process, not an event. In the process, there are three actors: portfolio manager, in–house trader, and broker, each with its own period of discretion. Costs of transacting should be attributed to the different actors according only to their periods of discretion. High–turnover portfolios should invest in systems that would allow estimation of the costs attributable to each actor9s decisions. The authors illustrate how this might be done.

Alternative Investments in the Institutional Portfolio

This study provides an update of an earlier analysis (Schneeweis and Spurgin, [1999]) of the risk and return benefits of various hedge funds and managed futures investments as stand-alone investments or as part of an investor9s diversified stock/bond portfolio. Both traditional Markowitz efficient frontiers with and without investment restrictions as well as the risk and return performance of portfolios constructed from adding alternative investments to established U.S. stock and bond portfolios are evaluated. The Markowitz efficient frontier determination is conducted using alternative methods of risk and return forecasting including 1) historical returns, and 2) the construction of ex ante return forecasts in which expected returns are based on their historical return to risk relationship; that is, ex ante return forecasts are constructed from cross-sectional OLS regressions of historical return on historical variance and are used as inputs into the Markowitz portfolio optimization model. The latter approach reduces the impact of historically high (low) abnormal returns from influencing the allocation process.