Positive Alpha Research Articles

Why Don’t Most Mutual Funds Short Sell?

An intriguing observation in the US mutual fund industry is that most equity funds do not short sell, even though virtually all regulatory restrictions on short selling were lifted by 1997. We shed light on this puzzle by conducting the first systematic analysis of long-short equity funds’ portfolio compositions, fund performance, and capital flows. Our results reveal that: 1) long-short mutual funds hold substantially more cash than their long-only peers and have a market beta significantly below one; 2) long-short funds generate a large positive alpha of 5% a year in risky holdings but slightly underperform their long-only peers in total returns; and 3) long-short funds face much higher flow-performance sensitivities and are more prone to use cash to absorb capital flows. We discuss several possible explanations for these findings.

Personality Types, Demographic Variables and Roommate Relationship Satisfaction Among Undergraduates of Obafemi Awolowo University Ile-Ife, Nigeria

The formation of a successful and satisfying roommate relationship goes a long way in determining students’ social and academic functioning. The thrust of this paper was to examine the extent to which personality types can determine roommate relationship satisfaction among undergraduates of Obafemi Awolowo University Ile-Ife. The survey research design technique was employed for the study. A total of six hostels were selected using stratified random sampling technique (using sex as a stratum). From the six hostels, 900 undergraduates were selected using convenience sampling technique. Two instruments titled Students Roommate Relationship Satisfaction Scale (SRRS) and Personality Type Questionnaire (PTQ) were used to collect information from the undergraduates. The reliability of the instruments yielded positive alpha coefficient results of 0.77 and 0.71. The results showed that the majority of the undergraduates (83.5%) of Obafemi Awolowo University had moderate levels of roommate relationship satisfaction. The results of the study showed that there was significant relationship existing between personality types (A and B) and roommate relationship satisfaction among undergraduates (N = 861, rpb = -0.189, p 0.05) and a negative and significant relationship between age and roommate relationship satisfaction (χ2 = 4.521, p < 0.05).

Flow-Driven ESG Returns

I show that the performance of ESG investments is strongly driven by price-pressure arising from flows towards sustainable funds, causing high realized returns that do not reflect high expected returns. The coefficient linking ESG flows and realized returns is the product of two factors: The deviation of green funds' portfolios from the market portfolio and a flow multiplier matrix that is the inverse of the market's demand elasticity of substitution between stocks. Empirically, withdrawing 1 dollar from the market portfolio and investing it in the representative ESG fund increases the aggregate value of high ESG-taste stocks by 2-2.5 dollars. Under the absence of flow-driven price pressure, the aggregate ESG industry would have strongly underperformed the market from 2016 to 2021. Furthermore, the positive alpha of a long-short ESG taste portfolio becomes significantly negative.

The Impact of Short Selling in the Cross-Section of Corporate Bond Returns

This study fills the literature gap by employing the longest yet-analyzed period and introduces multiple short selling proxies to explain the relationship between short selling information and bond performance. We examine short selling signals derived from bond and equity markets and find both to be predictive of future corporate bond returns after optimization, especially for high yield securities. Additionally, we find the combination of equity and bond short selling signals to be superior to individual factors, generating positive alpha even after costs. The performance of a blended signal is robust against volatility in down-markets, such as the Covid-19 pandemic.

Pricing and Systematic Trading of Municipal Bonds

In this article, the authors propose a systematic approach for pricing and trading municipal bonds, leveraging the feature-rich information available at the individual bond level. Based on the proposed pricing framework, they estimate several models using ridge regression and Kalman filtering. In their empirical work, they show that the models compare favorably in pricing accuracy to those available in the literature. Additionally, the models are able to quickly adapt to changing market conditions. Incorporating the pricing models into relative value trading strategies, the authors demonstrate that the resulting portfolios generate significant excess returns and positive alpha relative to the Vanguard Long-Term Tax-Exempt Fund (VWLTX), one of the largest mutual funds in the municipal space.

CAN WINNERS KEEP WINNING? AN ANALYSIS OF PERFORMANCE PERSISTENCE OF MUTUAL FUNDS AND HEDGE FUNDS IN CHINA

This paper investigates the performance persistence of both mutual funds and hedge funds using China’s data covering the period from January 2010 to December 2019. We first use a nonparametric method to examine the performance persistence with net return and Sharpe ratio over monthly, quarterly, semiannual, and annual intervals. We first find evidence that performance persistence exists in some years for both mutual funds and hedge funds. Then we construct portfolios based on lagged one-year returns and estimate their performance. We find top-performing portfolios of hedge funds that can get significantly positive alpha while no portfolio of mutual funds can get positive alpha.

IRR: Snake Oil by Another Name

Finance uses the phrase “risk-adjusted returns” to define what value is, and fiduciaries are legally bound to consider both risk and reward in investment decision-making. This requirement is codified in the Uniform Prudent Investor Act, which states, “The trade-off in all investing between risk and return is identified as the fiduciary’s central consideration.” Yet, the most prominent performance metric in private equity (PE) is the internal rate of return (IRR), an inadequate tool for fiduciary purposes because it includes no concept of risk, which represents fully half of the characteristics that fiduciaries are obligated to evaluate. An astute fund manager can exploit this willingness of PE investors to pay for returns that are not creating positive alpha. The key to understanding how a manager can do this lies in examining the role that financial leverage plays in the returns of PE funds and how such financial leverage affects IRRs. Metrics built on the direct alpha public market equivalent (PME) analysis are appropriate to estimate the risk-adjusted returns generated by PE funds and to fulfill fiduciary duties. TOPICS:Private equity, fundamental equity analysis, performance measurement, equity portfolio management Key Findings • The IRR metric is wholly inadequate to perform the function of a fiduciary because it has no concept of risk, which constitutes fully half of the characteristics that fiduciaries are obligated to evaluate. • An astute fund manager can exploit the willingness of PE investors to pay for returns that are not creating positive alphas. • Metrics built on the direct alpha PME analysis are most appropriate to capture the risk and return characteristics that fiduciaries are legally required to consider.

Practical Applications of A Performance Update—Hedge Funds versus Hedged Mutual Funds: An Examination of Equity Long—Short Funds

Practical Applications In A Performance Update—Hedge Funds versus Hedged Mutual Funds:An Examination of Equity Long–Short Funds. from the Fall 2020 issue of The Journal of Alternative Investments, authors David F. McCarthy (of D. F. McCarthy LLC in Stockbridge, MA) and Brian M. Wong (an independent consultant in Mamaroneck, NY) extend the research McCarthy began in 2014. At that time, McCarthy studied equity long–short mutual funds and compared them to hedge funds that use long–short strategies. He found that long–short mutual funds offered performance and equity exposures similar to those of hedge funds—but since the available data came from a short time period (January 2008—June 2013), the findings were preliminary. In the current study, McCarthy and Wong update the 2014 study with data through December 2019. They find that long–short funds still offer lower volatility and equity exposures similar to those of hedge funds. However, long–short funds perform slightly worse than hedge funds and much worse than the S&P 500 Index. They also generate negative alpha—and no individual long–short fund generated positive alpha during the study period. This is important information for financial advisors to share with clients who are interested in equity long–short funds. TOPICS:Real assets/alternative investments/private equity, mutual funds/passive investing/indexing, performance measurement

Mutual Fund Trading Style and Bond Market Fragility

Abstract We explore the link between mutual funds and fragility risk in the corporate bond market. We classify a fund’s trading style based on its responses to signals of large dealer inventories. Trading style is persistent and the majority of funds demand liquidity. Notably, a subset of funds earn positive alpha by intentionally supplying liquidity during periods of sustained customer selling (with transitory price effects). Liquidity-supplying funds maintain their relative trading style when facing large outflows and elevated market stress, thus alleviating fragility risk. Our results add nuance to existing evidence that mutual funds pose a threat to market stability.

Hedge Fund Performance in Japan

The decades of 1990s and 2000s in Japan are periods of economic stagnation and price deflation or the ‘lost 20’. Stock market has been anemic while the bond market has underperformed most developed markets. Hedge Funds (HFs) have played an extremely important role over the last two decades in Japan by forcing firms to increase distributions and making changes required to increase firm value. This paper looks at the performance of HFs in Japan using survivor bias free Eurkeahedge HF Index from January 2000 to September 2018 and compares them to Japanese stocks, bonds, and real estate. We find that HFs have significantly outperformed stocks and bonds but underperformed real estate. However, risk-adjusted performance (Sharpe, Sortino, and Omega Ratios) of HFs was much better compared to all other asset classes. HFs also had the smallest maximum drawdown, the shortest recovery period and have created the most wealth. HFs also had significantly positive alpha. Overall, results indicate that HFs in Japan have created lot of value compared to Japanese stocks and bonds.

Inside the director network: When directors trade or hold inside, interlock, and unconnected stocks

Abstract Analysis of shareholdings reveals that corporate directors generate positive alpha when they hold board interlocked stocks, where they are not an insider but a current co-board member is. In contrast, directors do not outperform when they hold inside stocks or other stocks unconnected to the board network. Analysis of trades shows that directors outperform when they buy or sell their own company's stock as insiders. They also outperform when they buy interlocked stocks. Results are similar for trades made before firm-specific information events. We also find limited support for the hypothesis that industry familiarity improves performance.

A Performance Update—Hedge Funds versus Hedged Mutual Funds: An Examination of Equity Long–Short Funds

This article presents a performance update for the equity long–short mutual funds that were first described and analyzed in McCarthy (2014), extending that analysis to the period from July 2013–December 2019. The analyses confirm that the equity long–short mutual funds provide investment exposure similar to leading equity long–short hedge fund indexes. However, in this later time period, they underperformed the S&P 500 Index and traditional hedge fund indexes. In addition, none of the indexes (i.e., the Index of Equity Long–short Mutual Funds, the HFRI Equity Hedge Fund Index, the DJ-CS L/S Equity Hedge Fund Index, or the CISDM Equity Long–Short Index [as modified]) had positive risk-adjusted returns, as measured by alpha over this later period, and none of the 24 equity long–short mutual funds with full data for the period from July 2013–December 2019 had positive alpha. This article also presents data on the lack of performance persistence across the equity long–short mutual funds, analyzes the considerable change in asset sizes of some of these funds, reports on the closure rate of equity long–short mutual funds over this time period, and notes the positive relationship between excess performance over the S&P 500 Index and equity long–short mutual fund net asset flows. Finally, the appendix broadens the analysis to include equity long–short mutual funds started after July 2013. The performance results from this expanded universe of funds is materially the same as the original sample of mutual funds from 2013. TOPIC:Mutual fund performance Key Findings This article examines equity long-short mutual funds over the period from July 2013–December 2019. It extends an earlier analysis of these same mutual funds through June 2013 (McCarthy 2014) and finds the following: a) Equity long–short mutual funds continue to provide investment exposure similar to equity long–short hedge funds. b) Equity long–short mutual funds have substantially underperformed the S&P 500 Index in absolute return terms over the analysis period (3.4% p.a. vs. 13.7% for the S&P 500). Moreover, as a group, they generated negative alpha over this period (−4.0% p.a.). Further, no individual equity long–short mutual fund included in the analysis earned a positive alpha over this six-and-a-half-year period. c) Equity long–short mutual funds performed similarly to, although slightly behind, leading equity long-short indexes over the analysis period. d) Over the analysis period, no persistence in individual equity long–short mutual fund manager performance was identified. Additionally, as a group and individually, equity long–short mutual funds had difficulties maintaining their asset levels. Only one of the largest five funds in 2013 was still among the five largest at the end of 2019. The article also includes performance data for equity long–short mutual funds begun after June 2013. The results are largely indistinguishable from the funds begun before that date. That is, this expanded universe of funds also substantially underperformed the S&P 500 Index, as a group did not earn positive alpha, and underperformed leading hedge fund indexes.

Sustainable Investment - Exploring the Linkage between Alpha, ESG, and SDG's

Environmental, Social and Governance (ESG) investing has been one of the most important topics in asset management this past decade. Yet, for all the attention, only a fraction of asset managers truly consider ESG issues when making investment decisions. This is partly due to the perceived conflict of ESG investing with an asset manager’s fiduciary duty and partly due to low-quality ESG data despite the near ubiquity of sustainability reports. We analyze the relationship between alpha generation and ESG metrics, and measure the impact companies have on the U.N.’s Sustainable Development Goals (SDG´s). First, we construct a sector-neutral portfolio using MSCI ESG momentum scores from 2013 to 2018, and determine that it is feasible to generate positive alpha vis a vis the MSCI US index. Second, we utilize structured and unstructured data to determine a company’s net influence on the SDGs, what we call its SDG ‘footprint.’ We show that an ESG momentum portfolio both outperforms the MSCI US index and has a relatively better SDG footprint than that of the index. Third, we establish a positive contemporaneous connection between the portfolio’s ESG ratings momentum and its SDG footprint. Thus, a positive linkage exists between ESG, alpha, and the SDG’s.

Alpha Alchemy: Diversifying Without Diluting Alpha

Managers are often evaluated and selected on the basis of their portfolio’s stand-alone risk and return properties. This is too narrowly focused. The basics of mean-variance optimization tells us that covariance and the relationship of a security’s returns within the context of the overall portfolio is important. We illustrate how the basics of portfolio construction with individual securities also applies to building a portfolio of managers. First, we show the statistical properties of different asset classes, as more and more managers are used to get exposure to the asset class. Depending on the asset class, tracking error, relative skewness, and relative excess kurtosis improve at different rates. This is important for considering how many managers may be necessary to get exposure to an asset class. We then illustrate an optimization method of combining the managers. Although the managers, on their own, may not have statistically positive alphas, they can be combined in a way to improve the likelihood that the portfolio of managers has a statistically positive alpha. The optimization method is not a substitute for traditional due diligence. It is just one additional tool useful for manager selection and portfolio construction. TOPICS:Wealth management, portfolio construction, manager selection Key Findings • Combining managers can reduce tracking error, but the relationship between tracking error reduction and manager addition depends on the asset class. Specifically, it depends on the average tracking error and average correlation of excess returns within an asset class. • A slightly modified Sharpe ratio is equivalent to a t-value. An information ratio (with Jensen’s alpha in the numerator) can also be interpreted as t-value. Maximizing these ratios is equivalent to maximizing confidence that the excess return or alpha will be positive. • Individual managers with no or even negative alpha can be combined to give positive alpha.

Abstract A39: Inflammatory macrophage derived TNF alpha induces downregulation of estrogen receptor alpha in breast cancer cells by inactivation of Foxo3A

Abstract Breast cancers are divided into different subtypes based on receptor expression status: estrogen receptor (ER), progesterone receptor (PR) and Her2. The luminal A subtype (ER+PR+Her2-) is most often associated with a good prognosis while the triple-negative (TN) cancers (ER-PR-Her2-) have a poor prognosis. ER+ cancer cells depend on estrogen for their growth and can be treated with drugs to block its effects. While most human breast cancers express ER alpha, some tumors are hormone independent despite the presence of ER and others become ER negative over time. Myeloid cells are known to affect tumor development, and infiltration of tumor-associated macrophages is associated with a worse prognosis. Theoretically, however, macrophages can be both beneficial and bad for the patient. Proinflammatory M1 macrophages (CD68+ CD163-) can eliminate cancer cells and promote antitumor immune responses while anti-inflammatory M2 macrophages (CD163+CD68+) or anti-inflammatory myeloid cells (CD68-CD163+) can promote tumor progression by inhibiting proinflammatory immune responses and induce wound-healing processes. This includes angiogenesis and matrix degradation, both of which promote metastatic spread and possibly even EMT. Macrophages have also been proposed to downregulate ER in breast cancer cells through an unknown mechanism. Due to the recent reports suggesting that macrophages can induce EMT and downregulate ER, we evaluated the effect of human primary macrophages on ER expression in breast cancer cells. Immunohistochemistry analyses of breast cancer tumor xenografts, established with co-transplantation of primary human myeloid cells together with ER+ breast cancer cells in NSG mice, showed association of monocytes with downregulation of ER-receptor expression. Using primary human monocyte-derived macrophage cultures In vitro, we show that the different subtypes of macrophages have unique cytokine secretion profiles with M1 macrophages secreting significantly higher levels of TNF alpha compared to M2 macrophages. ER alpha positive MCF-7 and ER alpha negative MDA-MB-231 breast cancer cells were cultured in macrophage condition media, and both Western blot and qPCR analysis showed downregulation of ER was caused by M1 macrophage-derived TNF alpha that inhibits FoxO3A transcription of ER alpha. We propose that proinflammatory macrophages (M1), despite being tumoricidal, may have direct effects on endocrine resistance in breast cancer patients. Our findings suggest that different macrophage subtypes have various and unique impacts on breast cancer progression, and that proinflammatory macrophages, despite being tumoricidal, may have unwanted and direct effects on endocrine resistance mechanisms in breast cancer patients. Citation Format: Frida Björk Gunnarsdottir, Catharina Hagerling, Caroline Bergenfelz, Camilla M. Rydberg, Meliha Mehmeti, Roni Allaoui, Sofie Mohlin, Sven Påhlman, Daniel Bexell, Karin Leandersson. Inflammatory macrophage derived TNF alpha induces downregulation of estrogen receptor alpha in breast cancer cells by inactivation of Foxo3A [abstract]. In: Proceedings of the AACR Special Conference on Tumor Immunology and Immunotherapy; 2018 Nov 27-30; Miami Beach, FL. Philadelphia (PA): AACR; Cancer Immunol Res 2020;8(4 Suppl):Abstract nr A39.

Public Sentiment and the Price of Corporate Sustainability

Combining corporate sustainability performance scores based on environmental, social and governance (ESG) data with big data measuring public sentiment about a company’s sustainability performance, I find that the valuation premium paid for companies with strong sustainability performance has increased over time and that the premium is increasing as a function of positive public sentiment momentum. An ESG factor going long on firms with superior or increasing sustainability performance and negative sentiment momentum and short on firms with inferior or decreasing sustainability performance and positive sentiment momentum delivers significant positive alpha. This low sentiment ESG factor is uncorrelated with other factors, such as value, momentum, size, profitability and investment. In contrast, the high sentiment ESG factor delivers insignificant alpha and is strongly negatively correlated with the value factor. The evidence suggests that public sentiment influences investor views about the value of corporate sustainability activities and thereby both the price paid for corporate sustainability and the investment returns of portfolios that consider ESG data.

Public Sentiment and the Price of Corporate Sustainability

Combining environmental, social, and governance (ESG) data with “big data” measuring public sentiment about corporate sustainability performance, I found that the valuation premium for strong sustainability performance increases as a function of positive momentum in public sentiment. An ESG factor long (short) on companies with superior (inferior) sustainability performance and negative (positive) ESG sentiment momentum delivered significant positive alpha. In contrast, the high-sentiment ESG factor delivered insignificant alpha and was negatively correlated with the value factor. The evidence suggests that public sentiment influences investor views about the value of sustainability activities and that big ESG data can be useful in identifying “value” ESG stocks.

Using questionnaires and task-related EEG signals to reveal hindered reappraisal and biased suppression in individuals with high schizotypal traits

Although impaired ability to regulate emotion is commonly reported in schizophrenic patients, the exact pattern of regulation of negative emotions in high-risk individuals remains unclear. In the current study, 26 high-schizotypy individuals paired with 26 controls completed an emotion regulation questionnaire (ERQ) and a laboratory emotion regulation task with electroencephalogram (EEG) recording. Two emotion regulation strategies, namely, reappraisal and expression suppression, were concurrently examined. The late positive potential (LPP) and frontal alpha asymmetry (FAA) were selected as two independent neural indicators of the emotion regulation effect. In the ERQ questionnaire, individuals in the high schizotypy group reported higher habitual use of suppression than the controls. During the emotion regulation task, the high schizotypy group showed no early LPP reduction in reappraisal compared with the control group and exhibited a general negative FAA pattern (left-biased alpha). In conclusion, we found that individuals with high schizotypy exhibited maladaptive regulation of negative emotions, manifested in hindered reappraisal and biased suppression; this may exacerbate the negative affect of such emotions and further serve as a risk factor for psychosis conversion. Early interventions targeting the regulation of negative emotions may be beneficial for individuals with high schizotypal traits.

Mutual Fund Performance at Long Horizons

Measures of investment performance, including alpha, the canonical measure of mean return after allowing for systematic (beta) risk, depend on return measurement horizon, because beta depends on horizon. We introduce a procedure that relies on a combination of theory and simulations to estimate long-return-horizon alphas and betas from short-horizon estimates. Compared to a benchmark of 41% estimated in monthly returns, the percentage of mutual funds with positive alpha estimates against the SPY decreases to 21% (increases to 46%) at the decade return horizon for funds with high (low) estimated monthly market betas. Alphas estimated from short-horizon (e.g. monthly) returns may be uninformative or even misleading regarding fund performance for investors with longer horizons.

Riding the Nordic German Power-Spread: The Einar Aas Experiment

Inspired by the initial success and eventual failure of Einar Aas' trading strategy exploiting dynamical patterns in the spread between Nordic and German electricity futures, we investigate the question whether there is evidence for possible arbitrage from engaging in both markets simultaneously and the possibility of constructing a trading strategy that ultimately beats the markets. To do this, we first assess the risk premium and relevant Sharpe values for the two markets and observe significant differences. This is followed by a discussion as to how far the different risk premia and Sharpe values alone are evidence of arbitrage. The answer is, they are not. However, we then show that an intelligently chosen long-short strategy constructed in the Einar Aas spirit can generate a positive alpha in the CAPM sense, hence providing evidence of arbitrage.