Portfolio Transition Research Articles

Pricing and mispricing of accounting fundamentals: Global evidence

This paper extends the fundamentals-based valuation model in Nichols et al. (2017) to global, developed equity markets. The model is able to explain, on average, 81% of the cross-sectional share price variation among global stocks. To be applicable among international markets, actual cash-flow streams instead of clean surplus accounting figures are used to reflect the different importance of dividends and share repurchases around the world. Firms identified as undervalued outperform overvalued firms by 0.62% p.m. after controlling for size, book-to-market, operating profitability, investment, and momentum. This premium is further not explained by lottery-like stock preferences (MAX, idiosyncratic volatility, skewness), mispricing related variables (FSCORE, ΔXFIN), or stock issuances. In support of a mispricing related explanation, we detect a significant post publication return decline in the easily exploitable long portfolio leg comprising undervalued stocks. Together with our analysis on investor sentiment, portfolio transitions, and arbitrage asymmetry, we provide evidence that deviations of the share price from the model’s estimated value indicate actual mispricing and according returns are unlikely to be a compensation for risk exposure.

An open-source extendable model and corrective measure assessment of the 2021 texas power outage

• An open-source Texas power grid model with real blackout data is available. • Model-based simulation captures key characteristics of the 2021 Texas blackout. • The sensitivity of corrective measures on event severity mitigation is quantified. • Per-GW generator winterization has distinct performance. Unprecedented winter storms that hit across Texas in February 2021 have caused at least 69 deaths and 4.5 million customer interruptions due to the wide-ranging generation capacity outage and record-breaking electricity demand. While much remains to be investigated on what, how, and why such wide-spread power outages occurred across Texas, it is imperative for the broader macro energy community to develop insights for policy making based on a coherent electric grid model and data set. In this paper, we collaboratively release an open-source extendable model that is synthetic but nevertheless provides a realistic representation of the actual energy grid, accompanied by open-source cross-domain data sets. This simplified synthetic model is calibrated to the best of our knowledge based on published data resources. Building upon this open-source synthetic grid model, researchers could quantitatively assess the impact of various policies on mitigating the impact of such extreme events. As an example, in this paper we critically assess several corrective measures that could have mitigated the blackout under such extreme weather conditions. We uncover the regional disparity of load shedding. The analysis also quantifies the sensitivity of several corrective measures with respect to mitigating the severity of the power outage, as measured in Energy-not-Served (ENS). This approach and methodology are generalizable for other regions experiencing significant energy portfolio transitions.

A Time Series Sustainability Assessment of a Partial Energy Portfolio Transition

Energy portfolios are overwhelmingly dependent on fossil fuel resources that perpetuate the consequences associated with climate change. Therefore, it is imperative to transition to more renewable alternatives to limit further harm to the environment. This study presents a univariate time series prediction model that evaluates sustainability outcomes of partial energy transitions. Future electricity generation at the state-level is predicted using exponential smoothing and autoregressive integrated moving average (ARIMA). The best prediction results are then used as an input for a sustainability assessment of a proposed transition by calculating carbon, water, land, and cost footprints. Missouri, USA was selected as a model testbed due to its dependence on coal. Of the time series methods, ARIMA exhibited the best performance and was used to predict annual electricity generation over a 10-year period. The proposed transition consisted of a one-percent annual decrease of coal’s portfolio share to be replaced with an equal share of solar and wind supply. The sustainability outcomes of the transition demonstrate decreases in carbon and water footprints but increases in land and cost footprints. Decision makers can use the results presented here to better inform strategic provisioning of critical resources in the context of proposed energy transitions.

Tax-Efficient Portfolio Transition: A Tax-Aware Relaxed-Constraint Approach to Switching Equity Managers

For a taxable investor with a highly appreciated equity portfolio, replacing the portfolio manager is likely to trigger substantial tax liabilities. We focus on transitioning an appreciated equity portfolio to an actively managed strategy. We compare transition from an appreciated portfolio to a traditional long-only tax-agnostic equity strategy with transition to equity strategies utilizing more-advanced portfolio management techniques such as tax-aware rebalancing and relaxed-constraint portfolio construction. We find that transition to a tax-aware relaxed-constraint strategy results in both high implementation efficiency and tax efficiency both during and after the transition. As a result, a tax-aware, relaxed-constraint, post-transition strategy significantly outperforms a traditional tax-agnostic, long-only strategy in its ability to preserve and grow the investor’s after-tax wealth over the long term. We also discuss risks and limitations of the tax-aware, relaxed-constraint approach. <b>TOPICS:</b>Wealth management, equity portfolio management <b>Key Findings</b> ▪ For an individual taxable investor with an appreciated equity portfolio, the tax costs of replacing the portfolio manager may be highly punitive, far outweighing the transaction costs of such replacement. ▪ Advanced portfolio management techniques can help alleviate the tax burden of portfolio transition resulting from manager replacement: We show that transition to a tax-aware relaxed-constraint strategy results in high implementation efficiency and tax efficiency both during and after the transition, leading to strong after-tax performance. ▪ We also show that tax-aware portfolio transition is a complex bespoke solution and stress the need for a careful evaluation of the client-specific situation by a client’s investment advisor and a prospective manager. Nonetheless, our results demonstrate that a tax-aware transition to a relaxed-constraint strategy has the potential for providing a substantial benefit to a taxable investor “locked-in” into a highly appreciated portfolio.

Large Bets and Stock Market Crashes

For five stock market crashes, we compare price declines with pre- dictions from market microstructure invariance. Predicted price de- clines half as large as the 1987 crash and almost equal to the 2008 sales of Societe Generale suggest that useful early warning systems are feasible. Larger-than-predicted temporary price declines during two flash crashes suggest rapid selling exacerbates transitory price impact. Smaller-than-predicted price declines for the 1929 crash sug- gest slower selling stabilized prices and less integration made markets more resilient. Quantities sold in the three largest crashes suggest fatter tails or larger variance than the log-normal distribution esti- mated from portfolio transitions data. JEL: G01, G28, N22

Portfolio Considerations in Trading

In today’s turbulent marketplace with unprecedented portfolio turnover, transition activity and drawdowns, one must identify and eliminate all sources of Sharpe ratio erosion. In this environment, trading costs and risks are significant contributors to this performance drag and avoiding them is the subject of this article. We observe and explain how common trading methods tend to increase costs and risks, and bridge the gap between portfolio management and the trade by introducing portfolio considerations in trading. Our techniques seek best execution from a portfolio perspective in accordance with Article 2 of the Uniform Prudent Investor Act.

The impact of salinity on paddy production and possible varietal portfolio transition: a Vietnamese case study

Increasing soil salinisation is an environmental stressor that causes significant reduction in crop productivity and increases the risk of farming and hence reduces the cultivated land area. For these reasons, soil salinisation is considered to be one of the most serious problems threatening food security. In the north central coastal region of Vietnam, saltwater intrusion in the dry season is a major concern for rice farming. To better understand the adverse impacts of soil salinisation in crops, this study investigates impacts of salinity on mean and variability of rice yields in four communes of Thua Thien Hue Province. In addition, the study looks at possible changes in the portfolio of rice cultivars, which would offer farmers the potential to increase yields and decrease yield variability simultaneously. Results clearly showed that salinity had an impact on yield levels, resulting in an average yield loss of 0.164 tonnes/ha from mean yield levels per unit increase of electrical conductivity. The results did not show that increasing salinity contributes to an increase in variability of yields, but points to the fact that saline water intrusion may lead to consistently lower yields in the study area. Results also indicate that farmers with smaller, scattered plots could be disproportionately affected by salinity and be less capable of managing the saline soils. In addition, saline conditions may also drive the increased use of environmentally damaging inputs, such as pesticides, to offset the decline in yields and thereby potentially lead to a vicious circle. Utilisation of an optimised portfolio of rice varieties that combine profit maximisation and risk reduction reveals that farmers can benefit from revised portfolios of existing varieties at initial salinity levels, but need to include salt-resistant varieties in the portfolio as salinity levels increase.

Portfolio choice, portfolio liquidation, and portfolio transition under drift uncertainty

This paper presents several models addressing optimal portfolio choice, optimal portfolio liquidation, and optimal portfolio transition issues, in which the expected returns of risky assets are unknown. Our approach is based on a coupling between Bayesian learning and dynamic programming techniques that leads to partial differential equations. It enables to recover the well-known results of Karatzas and Zhao in a framework a la Merton, but also to deal with cases where martingale methods are no longer available. In particular, we address optimal portfolio choice, portfolio liquidation, and portfolio transition problems in a framework a la Almgren–Chriss, and we build therefore a model in which the agent takes into account in his decision process both the liquidity of assets and the uncertainty with respect to their expected return.

Product platforms as a lever of competitive advantage on a company-wide level: a resource management perspective

In many industries, companies use product platforms as a means to reduce costs and obtain access to multiple market segments by developing different product variants. Product platforms are a collection of modules or parts that are common to a number of products. This commonality is developed intentionally to achieve desired effects in order to create value. The existing product platform literature provides many insights from a product-level perspective. Here, we analyze the strategic role of product platforms on a company-wide level. We discuss product platforms in the context of resource management approaches and analyze whether and to what extent understanding product platform as resources can help companies improve their strategic market position. The results are integrated into an adapted framework for product platforms as manageable resources. We emphasize the role of product platforms in the resource portfolio transition of a company: companies can use resources like skilled employees to create product platforms as superior resources. To ensure the productive use of these resources during product development, a systematic management process is required. Within that process, product platform resources have to be bundled with other resources and/or capabilities. Sustainable success for a company is achieved when its platform knowledge is synchronized with other units across management levels over time. Thinking of product platforms as resources helps companies to better understand the strategic value of these platforms and find ways to make use of them to create competitive advantages.

Water for Energy: Systems Integration and Analysis to Address Resource Challenges

Water for the energy sector is an interdisciplinary challenge that requires new integrated systems knowledge, well-documented case studies that test various decision processes, and both quantitative and qualitative modeling and analyses to support sustainable decision-making. This review paper highlights water requirements of the energy sector and summarizes interdisciplinary research opportunities for sustainable and efficient management of water for energy, and new datasets to inform analysis of water policies and programs affecting energy systems. The energy sector depends closely on water resources for primary fuels production (including extraction or cultivation, processing, and refining) and electric power generation in thermoelectric and hydroelectric power plants. While research in these areas has advanced significantly in recent years, questions remain regarding water quality and quantity impacts of emerging technologies and policies in the water-energy sectors, potential for use of alternative water resources, impact of energy portfolio transitions, and tools to aid decision-making under uncertainty. Water is essential for energy production and power generation processes. Projected transitions in energy portfolios and water for energy policy hold the potential to both mitigate or exacerbate water stress, therefore motivating a critical need for systems integration and analysis approaches that can guide the development of cost-effective, resource-efficient, and resilient systems and services.

Min-Regret Methods in Portfolio Transition

Investors often regret their trades. Regret can significantly impact their strategic decisions, for example, by making them abandon a pre-planned investment strategy during stressed market conditions. Therefore, minimizing expected regret is a prudent way to construct investment strategies. We propose to measure the cost of regret as a price of regret protection option, and apply this new metric to portfolio transition strategies, where the objective is to increase (or decrease) risky exposures over a specified period of time. Regret-averse investors should design their portfolio transition with low cost of regret.

Comparing Transition Track Records: An Attempt to Create Like-for-Like Comparisons

This article discusses the issues one encounters when comparing transition track records. Different transition benchmarks, different (sub)asset class classifications, fair versus unfair, and differences in pretrade assumptions and client instructions affect transition composites/track records and make reliable comparison difficult. To remove the need to subdivide transitions and simultaneously address the problem of insufficient transition events, one can apply an independent sophisticated post-trade algorithm. Such an algorithm takes into account the differences in market volatility, liquidity, and price movements of each security during the transition. An algorithm basically normalizes the multiple variations of portfolio transitions so they can legitimately be compared against each other in a broader universe. <b>TOPICS:</b>Performance measurement, quantitative methods

Market Microstructure Invariance: Empirical Hypotheses

Using the intuition that financial markets transfer risks in business time, “market microstructure invariance” is defined as the hypotheses that the distributions of risk transfers (“bets”) and transaction costs are constant across assets when measured per unit of business time. The invariance hypotheses imply that bet size and transaction costs have specific, empirically testable relationships to observable dollar volume and volatility. Portfolio transitions can be viewed as natural experiments for measuring transaction costs, and individual orders can be treated as proxies for bets. Empirical tests based on a data set of 400,000+ portfolio transition orders support the invariance hypotheses. The constants calibrated from structural estimation imply specific predictions for the arrival rate of bets (“market velocity”), the distribution of bet sizes, and transaction costs.

Market Microstructure Invariance: Empirical Hypotheses

Using the intuition that financial markets transfer risks in business time, “market microstructure invariance” is defined as the hypotheses that the distributions of risk transfers (“bets”) and transaction costs are constant across assets when measured per unit of business time. The invariance hypotheses imply that bet size and transaction costs have specific, empirically testable relationships to observable dollar volume and volatility. Portfolio transitions can be viewed as natural experiments for measuring transaction costs, and individual orders can be treated as proxies for bets. Empirical tests based on a dataset of 400,000 portfolio transition orders support the invariance hypotheses. The constants calibrated from structural estimation imply specific predictions for the arrival rate of bets (“market velocity”), the distribution of bet sizes, and transaction costs.

A Method of Retail Mortgage Stress Testing: Based on Time‐Frame and Magnitude Analysis

AbstractIn this study, a non‐stationary Markov chain model and a vector autoregressive moving average with exogenous variables coupled with a logistic function (VARMAX‐L) are used to analyze and predict the stability of a retail mortgage portfolio, based on the stress test framework. The method introduced in this paper can be used to forecast the transition probabilities in a retail mortgage over pre‐specified states, given a shock with a certain magnitude. Hence this method provides a dynamic picture of the portfolio transition process through which one can assess its behavior over time. While the paper concentrates on retail mortgages, the methodology of this study can be adapted also to analyze other credit products in banks. Copyright © 2015 John Wiley &amp; Sons, Ltd.

Market Microstructure Invariants: Empirical Evidence from Portfolio Transitions

The hypothesis of “market microstructure invariance” — based on the intuition that the size and costs of transferring risk in “business time” is constant across assets and time — is tested using a database of 400,000 portfolio transition trades. Defining trading activity W as the product of dollar volume and returns standard deviation, microstructure invariance predicts that order size, market impact costs, and bid-ask spread costs (adjusted for volume and volatility) are proportional to W^{-2/3}, W^{1/3}, and W^{-1/3}, respectively. Estimated exponents of -0.63, 0.33, and -0.39 are close to the predicted values of -2/3, 1/3, and -1/3 respectively. The distribution of order size as a fraction of volume conforms closely to a log-normal with log-variance of 2.50. Calibration estimates for a benchmark stock with expected daily volume of $40 million and volatility of 2% imply that the median order size is 0.34% of average daily volume, market impact cost of trading one percent of daily volume is 2.89 basis points, and the bid-ask cost is 7.90 basis points.

Market Microstructure Invariants

Using the intuition that financial markets transfer risks in business time, we define “market microstructure invariance” as the hypothesis that the distribution of risk transfers (“bets”), transactions costs, market resiliency, and pricing accuracy are constant across assets when measured per unit of business time. A structural model of risk-neutral informed trading and noise trading with linear price impact shows that invariance relationships arise when the costs of informative signals are constant. The invariance hypotheses imply that microstructure variables like bet size and transactions costs have empirically testable relationships to observable dollar volume and volatility. Since portfolio transitions can be viewed as natural experiments for measuring transactions costs and individual orders can be treated as proxies for bets, we test these empirical predictions using a dataset of 400,000 portfolio transition orders and find that the predictions closely match the data.

Does consumption inequality track income inequality in Italy?

This paper presents stylized facts on labor supply, income, consumption, wealth, and several measures of consumption and income inequality drawn from the 1980–2006 Survey of Household Income and Wealth (SHIW) conducted by the Bank of Italy. The SHIW provides information on consumption, income and wealth, and a sizable panel component that allows econometricians to estimate sophisticated income, consumption, and wealth processes and to analyze labor market and portfolio transitions. We find that over the sample period income inequality is higher and has grown faster than consumption inequality. Most of the increase in income inequality is related to an increase in the degree of earnings' instability rather than to shifts in the wage structure. We suggest that, in particular, the labor market reforms of the 1990s and 2000s are the most plausible explanation of the increased earnings inequality.

Portfolio Transitions and Stock Price Dynamics

This paper employs a proprietary data set of portfolio transitions to analyze the short run price-volume relation and its association with the long run performance of newly hired and terminated managers. Unique to our study is its focus on price dynamics that is not afiected by potential endogeneity of trading decisions. In the short run, purchases of new stocks induce permanent price increases. Such price changes are especially pronounced for large orders as well as for stocks with a high degree of information asymmetry and negative past returns. In contrast, sales of legacy stocks induce only transitory price declines. In the long run, the evidence shows that institutional sponsors are able to hire managers that are, on average, more skilled than the terminated ones. The apparent beneflts of portfolio transitions, however, do not exceed transaction costs.

The Study of Price Impact and Effective Spread

Since traders often employ price-dependent strategies and cancel expensive orders, conventional estimates tend to overestimate available liquidity. This paper studies trading costs using the sample of portfolio transition trades. The known exogeneity of these trades eliminates the selection bias problem. We estimate a piece-wise linear price impact functions with the intercept corresponding to fixed spread costs and the slope corresponding to variable price impact costs. Buy orders are more expensive than sell orders due to specific institutional features of portfolio transitions. For high-volume stocks, small trades are executed at a discount relative to a piece-wise linear specification. Since the size of this discount is comparable to bid-ask spread, we attribute documented non-linearity to ability of portfolio transition managers sometimes to earn bid-ask spread instead of paying it by providing liquidity to other market participants.