Summary Of Applications Research Articles

Practical Applications of Spicing Up a Portfolio with Commodity Futures: Still a Good Recipe?

Practical Applications Summary As investors surged into commodity markets seeking stability in the aftermath of the financial crisis, correlations between equity markets and commodity futures increased, casting doubt on their ability to consistently provide the robust returns associated with their assumed low correlations. However, in Spicing Up a Portfolio with Commodity Futures: Still a Good Recipe?, Robert Daigler , Brice Dupoyet of Florida International University and Leyuan You of Texas State University find that a portfolio of individual commodity and equity futures is able to outperform an equity portfolio in terms of risk and return, during both equity and commodity bull and bear market periods.

Practical Applications of Factors Timing Factors

<h3>Practical Applications Summary</h3> With the popularity of factor investing and smart beta continuing to rise, many investors have developed an interest in factor timing to make strategic and tactical allocations to factors in order to enhance returns. One measure often used to assess the attractiveness of a factor is its current valuation—using a single-value-factor model to measure whether a particular factor, like low volatility, quality, or size, for example, is overvalued, fairly valued, or undervalued. In his article Factors Timing Factors, published in the 2017 special issue of <b><i>The Journal of Portfolio Management, Wai Lee</i></b>, managing director and global head of quantitative investments at Neuberger Berman, questions the utility of employing factors to time factors. He argues that attempting to time factors by using other factors has limited value, and that factor timers would be better served by focusing on the underlying rationale that give rise to a risk premium in the first place.

Practical Applications of Facts about Factors

<h3>Practical Applications Summary</h3> In Facts about Factors, published in the 2017 Special Issue of <b><i>The Journal of Portfolio Management</i></b>, <b>Paula Cocoma, Megan Czasonis, Mark Kritzman</b>, and <b>David Turkington</b> compare portfolio construction methods that are based on allocation to factors rather than using traditional building blocks such as asset class or industry sectors. “Because factors have an additional source of instability—mapping errors—factors are less stable than the traditional ways of grouping assets,” notes Kritzman. “Factors are obviously a very hot topic right now,” Turkington says. “But there is a lot of confusion about what factor investing means and the ways in which it adds value. We wanted to bring some clear analysis and new analytic perspectives to factors.”

Practical Applications of Embracing Downside Risk

Practical Applications Summary Many investors prefer to focus on maximizing their upside participation, since downside hedge protection can be expensive, and cut into long-term returns. But efforts to hedge out an asset’s downside risk can be expected to also reduce its returns. In Embracing Downside Risk, published in The Journal of Alternative Investments , Roni Israelov, Lars N. Nielsen, and daniel Villalon of AQR Capital Management show how downside risk is the primary basis for long-term rewards in equities and other asset classes. The authors use option prices to evaluate returns for investors in both upside and downside risk exposures. Instead of measuring the volatility risk premium as a volatility spread, they measure the return impact for investors following their asymmetric risk preferences. “The bottom-line: It’s the downside that pays. There’s a reason these things are called risk premia,” says Villalon in an interview with Institutional Investor Journals .

Practical Applications of Five Mysteries Surrounding Low and Negative Interest Rates

<h3>Practical Applications Summary</h3> Overview Five Mysteries Surrounding Low and Negative Interest Rates, published the Spring 2017 issue of <b><i>The Journal of Portfolio Management</i></b>, cautions practitioners against taking extreme measures in what may appear to be extreme times. Authors <b>Laurence B. Siegel</b> of the <b>CFA Institute Research Foundation</b> and <b>Stephen C. Sexauer</b> of the <b>San Diego County Employees Retirement Association</b> find that the so-called “mysteries” of negative rates can mostly be demystified by solid application of familiar economic theory. They urge long-term investors to take a conservative investment approach to the current climate, sticking to portfolio management fundamentals and steering clear of expensive alternative investments that promise high performance in a low-return world.

Practical Applications of The Returns of Private Equity Funds: A Swiss Perspective

<h3>Practical Applications Summary</h3> <b>Daniel Steger</b>, of <b>EIC Partners AG</b> in Zurich provides new research on private equity funds that will be of interest to both academics and practitioners. Building a unique database from detailed fund-level information, he seeks to bring clarity to private equity fund returns in absolute terms and relative to the public equity markets. Steger finds that PE funds tend to outperform the public markets, but because the results are heterogeneous, investors’ returns vary widely by the type of fund they choose, and the benchmarks used to measure the funds.

Practical Applications of Smart Beta Is the Gateway Drug to Risk Factor Investing

Practical Applications Summary Today’s most common strategies using risk factor approaches are found on the opposite ends of the complexity spectrum. On one end lie simple, long-only equity strategies based on factor tilts, such as low volatility, value, and momentum. Smart beta, at its most basic, is a good example. At the other end are the more complex, multi-asset-class, long/short, risk premia approaches that often employ leverage and derivatives. In Smart Beta Is the Gateway Drug to Risk Factor Investing, published in the Special Issue 2017 of The Journal of Portfolio Management , Eugene Podkaminer of Callan Associates establishes the two poles and explains the many opportunities that exist in the middle. As risk factors become a more common feature of both portfolio attribution and portfolio construction, the space between these two poles is just starting to be explored. Today’s simple factor smart beta portfolios can be extended across multiple asset classes, and coupled with shorting, may constitute a robust and diversified risk premia approach.

Practical Applications of Liquidity in the U.K. Corporate Bond Market: Evidence from Trade Data

Practical Applications Summary Corporate bonds are an essential source of financing for companies, and an important asset class for long-term investors. The UK markets can be murky, however: There is an abundance of issues, volumes can be low, and most trading is carried out between dealers and their clients with little data reported to the public. Matteo Aquilina and Felix Suntheim of the Economics Department of the UK Financial Conduct Authority have shed light on the UK market through their comprehensive study of individual trades between 2008 and 2014. They find that although dealer inventories have declined significantly, there is no evidence that liquidity has deteriorated in the market. “If anything, the market has become more liquid in the last few years,” they conclude.

Practical Applications of Accounting for Cross-Factor Interactions in Multi-Factor Portfolios without Sacrificing Diversification and Risk Control

Practical Applications Summary Increasing investor interest in multi-factor solutions has product providers debating the respective merits of the “top-down” and “bottom-up” approaches to multi-factor portfolio construction. In Accounting for Cross-Factor Interactions in Multi-Factor Portfolios without Sacrificing Diversification and Risk Control, published in the 2017 Special Issue of The Journal of Portfolio Management, Noel Amenc, Frederic Ducoulombier, Mikheil Esakia, Felix Goltz, and Sivagaminathan Sivasubramanian at ERI Scientific Beta compare the two strategies. They find that focusing on increasing composite factor scores through score-based weighting leads to inefficiency in capturing factor premia. High factor scores in score-weighted bottom-up approaches also come with high instability and turnover. The team introduces a hybrid approach that considers cross-factor interactions in top-down portfolios through an adjustment at the stock-selection level. The approach produces significantly higher factor intensity and improves absolute performance and risk-adjusted performance relative to the traditional approach while keeping turnover in check.

Practical Applications of Exchange-Traded Funds: Sector Performance and Diversification

Practical Applications Summary ETFs continue to be valuable asset allocation tools, especially for investors looking for specific sector exposures. But how confident can investors be that ETF returns will replicate their chosen sectors? And how broad should the benchmark be? In an interview with Institutional Investor Journals, Carl Luft of DePaul University explains that correlations are actually closer with sector indices that match the S&P 1500 index, versus the more frequently used S&P 500 index.

Practical Applications of The Moral Hazard Problem in Hedge Funds: A Study of Commodity Trading Advisors

<h3>Practical Applications Summary</h3> Research shows that poorly performing hedge funds tend to engage in risk-shifting behavior—increasing volatility—to boost returns and, in turn, performance fees, especially when fee structures contain triggers such as high-water marks. In <b>The Moral Hazard Problem in Hedge Funds: <i>A Study of Commodity Trading Advisors</i></b>, <b>Li Cai</b>, <b>Chris (Cheng) Jiang</b>, and <b>Marat Molyboga</b> demonstrate that the market environment affects risk-shifting behavior among hedge funds—less risk-shifting behavior occurs in unfavorable market environments, and vice versa. The study also provides new evidence linking investment strategy and risk choices. The authors find that although risk-shifting behavior can increase fees for managers, it lowers investors9 risk-adjusted returns.

Practical Applications of Will Long-Term Care Ruin Retirement Plans?

<h3>Practical Applications Summary</h3> As the American population ages, many families are encountering the expense of long-term care (LTC). While there are different types of care, nursing-home care is particularly expensive, with an average cost of more than $92,000 per year. Those costs heighten the risk of running out of retirement assets in old age, yet it’s impossible to know exactly how much long-term care will be needed as individuals age. In <b>Will Long-Term Care Ruin Retirement Plans</b>, published in the Winter 2017 issue of <b><i>The Journal of Retirement</i></b>, <b>Michael Crook</b> and <b>Ronald Sutedja</b> of <b>UBS Wealth Management</b> developed health-status simulations to predict the probability of needing long-term care after the age of 65. Next, they developed a model that assessed the financial impact of LTC costs on retirement plans ranging from $1 million to $10 million.

Practical Applications of Dividend Swaps and Dividend Futures: State of Play

Practical Applications Summary Asset managers are attracted to bilaterally negotiated OTC derivatives because of their flexibility and customized features, but they are hesitant to trade products with unknown liquidity and opaque pricing. Now, new mandatory regulatory data enables investors to quantify this vast marketplace and to use information about market size as a proxy for risk. Institutional Investor Journals talks with Scott Mixon and Esen Onur of the U.S. Commodity Futures Trading Commission (CFTC), whose article Dividend Swaps and Dividend Futures: State of Play peeks under the hood of the vast OTC index dividend swap market. “We can now look at that data, provide it to the markets, and understand much better what is going on in these previously opaque transactions,” says Mixon.

Practical Applications of The Case for the Cautious Use of Leverage

Practical Applications Summary After the global financial crisis, the investment community changed dramatically and investors went to great lengths to avoid leverage. In The Case for the Cautious Use of Leverage published in the Spring 2017 issue of The Journal of Wealth Management, Wei Ge of Parametric Portfolio Associates shows how leverage can be a useful financial tool when used appropriately. The judicious use of leverage may be especially helpful for institutional investors, especially in today’s environment of diminished growth expectations and ultra-low interest rates. Ge takes an in-depth look at the mechanisms of leverage, and provides examples on how to use leverage effectively without incurring significant unexpected risks. He spoke with Institutional Investor Journals about his work and the implications for investors in the current market environment.

Practical Applications of Defined Contribution Retirement Plans Should Look and Feel More Like Defined Benefit Plans

<h3>Practical Applications Summary</h3> Defined contribution (DC) retirement plans have largely replaced defined benefit (DB) pension plans, but DC plans, which were designed to be supplements to pensions, aren’t currently positioned to solve the looming retirement crisis in the United States. In <b>Defined Contribution Retirement Plans Should Look and Feel More Like Defined Benefit Plans</b>, <b>Antti Ilmanen, David Kabiller</b>, and <b>Rodney Sullivan</b> of <b>AQR</b> and <b>Laurence Siegel</b> of the <b>CFA Institute Research Foundation</b> show that DC retirement plans, as they currently stand, are inadequate to meet the challenges of our looming retirement crisis. They describe how the addition of features borrowed from DB plans can help DC plans improve retirement outcomes through better risk management and improved diversification of portfolios.

Practical Applications of Currency Crowdedness Generated by Global Bond Funds

Practical Applications Summary “There has been a great deal of research on factor investing in equities, but far less on the fixed income side,” says Gueorgui Konstantinov of LBBW Asset Management. In Currency Crowdedness Generated by Global Bond Funds, he works to rectify that gap, demonstrating that nearly half of the variance in global bond manager returns can be attributed to five currency factors. He also sends a clear practical message: many highly skilled bond managers are not good at active currency management, but rely heavily on these currency factor “betas,” resulting in crowded trades and greater risk. “Investors should keep a close eye on their managers’ style exposures,” cautions Konstantinov. He spoke with Institutional Investor Journals about his research and the original article was published in the Winter 2017 issue of The Journal of Portfolio Management.

Practical Applications of The Bad Arithmetic of Active Management

<h3>Practical Applications Summary</h3> As the debate between active and passive investors continues, it is useful to take a look back at the history of investment performance analysis. In <b><i>The Bad Arithmetic of Active Management</i></b><b>Brian Jacobsen</b> of Wells Fargo Funds Management takes a critical look at a touchstone of received wisdom on the issue of active versus passive investing, <b>William Sharpe’s</b> classic article, <b><i>The Arithmetic of Active Management</i></b>. The problem isn’t that Sharpe miscalculated, but that his categories are misnomers, and the assumptions that underpin them are deeply flawed. So even though the numbers add up, they can’t help you make the right choices between active and passive investments. In this interview with <b>Institutional Investor Journals</b>, Jacobsen explains why and what should be done to improve our analytical frameworks.

Practical Applications of Abnormal Stock Returns Using Supply Chain Momentum and Operational Financials

Practical Applications Summary A supply chain or supply network is a multicompany material-flow ecosystem, and operational data of customer companies can provide an indication of supplier companies’ future operations and business performance. In Abnormal Stock Returns Using Supply Chain Momentum and Operational Financials , published in the Winter 2017 issue of The Journal of Portfolio Management , authors Antti Paatela , Elias Noschis , and Ari-Pekka Hameri explain how an understanding of the interrelationships among supply chain partners’ businesses can provide an opportunity to gain abnormal investment returns in the stock market. Diverging from previous research, they focus on whole supply chains instead of single companies, on actual company financial data instead of more speculative stock market prices, and on the special dynamics of supplier–customer links.

Practical Applications of A Morality Tale of ESG: Assessing Socially Responsible Investing

<h3>Practical Applications Summary</h3> The standards of socially responsible investing continue to evolve, but the financial industry is beginning to reach a consensus on a framework for analysis. Collectively, the three components of social responsible investing (SRI) are known as environmental, social, and governance (ESG) factors. In <b>A Morality Tale of ESG:Assessing Socially Responsible Investing</b>, published in the Spring 2017 issue of <b><i>The Journal of Wealth Management</i></b>, <b>Edward Aw, Stephen LaPerla</b> and <b>Gregory Sivin</b> explore whether ESG factors are effective predictors of expected returns, both overall and on a component level. Additionally, they show the effect of overlaying ESG factors onto an existing investment process.

Practical Applications of Long Bonds for the Short Run

Practical Applications Summary When interest rates inevitably rise, will there be enough long-term corporate bonds to meet investor demand? In an interview with Institutional Investor Journals , Evan Inglis and Dave Wilson of Nuveen Asset Management explain that, given uncertainties regarding supply, investors should consider boosting allocations to long corporate bonds now. According to their analysis, this advice makes sense whether interest rates rise slowly or quickly from current levels.