Style Investing Research Articles

A Taxonomy of Beta Based on Investment Outcomes

The traditional active vs passive debate has been shaken up by the emergence of “smart beta” strategies. As the population of these products has exploded, the quest to differentiate among them has focused on portfolio construction techniques rather than what actually matters, namely investment outcomes. Yet it is crucial for asset owners considering a smart beta allocation to understand the wide dispersion of key performance results due to the starkly different investment approaches employed by these strategies. The purpose of this white paper is to redirect the conversation back where it belongs. Our taxonomy of smart beta strategies, supported by a comprehensive analysis of simulated historical returns over three decades covering both developed and emerging markets, distinguishes between three stated portfolio construction objectives (Enhanced Diversification, Factor Investing and Fundamental Weighting) and two investment outcomes (Core Exposure and Style Investing). The investment outcomes are characterized by performance patterns as well as qualitative considerations such as benchmark sensitivity, turnover levels, and underlying beliefs about market inefficiencies and the merits of broad diversification.

The Crash Risks of Style Investing: Can They Be Internationally Diversified?

The crash risks of momentum tend to be higher than those of size and value. International diversification lowers the crash risks of size and value but not momentum. The authors examined the conditional correlations and return co-exceedances of style portfolios across countries and found that this difference in the effect of diversification is due to the left (right) tails of momentum (size and value) portfolios being more correlated than the right (left) tails across countries.

A social-media-based approach to predicting stock comovement

Stock return comovement analysis is important to financial analysts, decision makers, and academic researchers and has many financial implications, such as portfolio management, style investing, and market risk detecting. This paper proposes a novel model to both identify homogeneous stock groups and predict stock comovement with respect to firm-specific social media metrics. One of the innovations of the social media platform is that it breaks traditional media intermediation. A firm with an official Twitter account can publish information and interact with its users directly. Such direct information is largely reflected on firm-specific metrics, e.g., the firm’s number of followers and number of tweets sent. To the best of our knowledge, this paper is the first to reveal the impact of social media metrics on stock return comovement studies. By analyzing samples from the NYSE and NASDAQ stock exchanges, we find that firms with official Twitter accounts have a much higher comovement than those without such accounts. Furthermore, we classify the former set of firms into homogeneous groups by their specific microblogging metrics. The results demonstrate that these metrics cannot only predict the comovement of stocks but also notably increase the accuracy of comovement predicting, compared with industry categories.

The Crash Risks of Style Investing: Can They Be Internationally Diversified?

Motivated by the growth in the popularity of style investing and the concern for extreme events among investors, we examine the tail risks of style investing in different countries. For the G7 countries over the 1981-2010 period, we evaluate whether portfolios with different size, value, or momentum tilts — the SMB (small minus big), HML (high minus low), and UMD (past winners minus past losers) portfolios — experience different crash risks, and whether these risks can be mitigated through international diversification. We find that the crash risks of momentum tend to be higher than those of size and value, where crash risks are measured by return skewness and expected shortfall. International diversification lowers the crash risks of size and value further, but has only limited effects on momentum. Specifically, a diversified, world UMD portfolio (equal-weighted portfolio of the G7 countries) tends to be more left-skewed and has a more negative expected shortfall than the momentum portfolios of individual countries. By contrast, the world SMB and HML portfolios tend to have less negative skewness and expected shortfall than their country-specific counterparts. By examining the conditional correlations and return coexceedances of style portfolios across countries, we find that the extreme negative returns on UMD in different markets tend to occur together, whereas those on SMB and HML tend to be country-specific. In fact, for SMB and HML, it is the right-tail events that tend to be more global in nature. These results suggest that the difference in the effect of international diversification is due to the left (right) tails of momentum (size and value) portfolios being more correlated than their right (left) tails across countries.

An Investigation into Sentiment-Induced Institutional Trading Behavior and Asset Pricing in the REIT Market

Institutional investors such as pension funds or insurance companies commonly invest in the unsecuritized and securitized real estate market. We investigate how institutional investor sentiment in the commercial real estate market affects institutional trading behavior in the REIT market and subsequently asset pricing. In particular, we test two alternative theories - flight to liquidity and style investing theory - to explain the sentiment-induced trading behavior of institutional investors in the REIT market for the pre-crisis (2002–2006), crisis (2007–2009) and post-crisis (2010–2012) period. We find that the applicability of either theory depends on economic conditions. In the pre-crisis period institutional investors switched capital in and out of REITs based on their sentiment in the private market (style investing). However, in the crisis period institutional investors switched capital from the illiquid private market to the more liquid REIT market (flight to liquidity). The flight to more liquid REITs continued into the post-crisis to a lesser extent and suggests that the financial crisis has changed institutional investment behavior. Our findings hold across different groups of REITs (e.g. high and low institutional ownership, S&P and non-S&P REITs) and property types. We also find that institutional real estate investor sentiment introduces a non-fundamental component into REIT pricing.

Hedge Fund Replication Using Shrinkage Methodologies

In this article, the authors replicate major Hedge Fund Research, Inc., style indexes using alternative methods. These methods include stepwise regression, ridge regression, the lasso method, the elastic net, dynamic linear regression, principal component regression, and partial least squares regression. They find generally that, across the major hedge fund style indexes, the best replication results are obtained with methods that employ shrinkage of parameters. <b>TOPICS:</b>Real assets/alternative investments/private equity, style investing, statistical methods, performance measurement

Industry Allocation of Equity Funds

Industry allocation preferences of equity fund managers are examined to identify how style investing from industry-dimensions influence fund performance and flows. Using Australian equity fund data, we show that the level of Industry Activeness, Industry Rotation and Industry Rotation Sensitivity, which are three market-relative industry allocation metrices, significantly affect both the performance and flows of retail and wholesale equity funds. These findings illustrate the significance of industry allocations in the role of style investing.

Microblogging Metrics and Stock Return Comovement

Stock return comovement analysis is important to financial analysts, decision makers, and academic researchers, in many financial implications, such as, portfolio management, style investing, and market risk detecting. This paper examines firms’ social media, in particular, microblogging metrics’ role on analyzing stock return comovement. Social media allows firms to proactively connect with public users, customers, suppliers, and other business partners. It also provides us a large-scale and free data set to automatically and quickly uncover firms’ social media metrics’ influence on financial outcomes. Most prior studies of social media metrics focused on overall firm metrics and their predictability on stock returns. However, the role of firms proactive activities has been omitted. This paper filled this gap by using cross-sectional data from the US and China to investigate on how firm-specific social media metrics make an impact to the stock return comovement. The results show starting with the four-digit Global Industry Classification Standard (GICS) system, the stock groups that are divided by firms’ effect microblogging metrics, have a higher comovement than six-digit GICS groups.

Mutual Funds Win and Investors Lose

This study examines the question of why investors continue to buy underperforming actively managed mutual funds. Four approaches to this question are discussed: 1) investor overconfidence; 2) strategic fund repricing decisions; 3) fund “sentiment contrarian behavior;” and 4) investor dependence on brokers with agency-conflicted incentives. <b>TOPICS:</b>Mutual fund performance, style investing, manager selection

Why Does ETF Short Selling Provide a Different Signal?

Short selling is of great interest to investors because it has predictive value for future stock returns. We investigate whether this extends to foreign stock ETFs. In contrast to regular stocks, ETFs with high short interest experience positive abnormal returns. Our analysis suggests that the creation and redemption of ETF shares influences the level of short selling. Foreign stock ETFs, with low short interest, also have positive abnormal returns. These abnormal returns are typically caused by higher prices in foreign stock markets and not exchange rate changes. <b>TOPICS:</b>Exchange-traded funds and applications, style investing, statistical methods

Style Preference Shift of Individual Investors and Stock Returns: Evidence from China

Using the trading records of individual investors in the Chinese stock market, this paper shows that the individual investors’ portfolios are significantly influenced by style investing. Consistent with behavioral theory, our findings suggest that the style returns are significantly affected by investors’ style preference shift. The greater the attention paid by individual investors or the higher arbitrage cost, the more sensitive the portfolio returns are to the individual investors’ style preferences shift.

Boosting the Liquidity of the Market Engine: Horsepowerversus Torque

In this commentary, we make the analogy between market liquidity and its components and engine torque and horsepower. This analogy is used to appreciate the importance of contrarian investing and enables us to think more clearly about the influence of potential regulatory changes. <b>TOPICS:</b>Legal/regulatory/public policy, style investing, analysis of individual factors/risk premia

Style investing, comovement and return predictability

Barberis and Shleifer (2003) argue that style investing generates momentum and reversals in style and individual asset returns, as well as comovement between individual assets and their styles. Consistent with these predictions, in some specifications, past style returns help explain future stock returns after controlling for size, book-to-market and past stock returns. We also use comovement to identify style investing and assess its impact on momentum. High comovement momentum portfolios have significantly higher future returns than low comovement momentum portfolios. Overall, our results suggest that style investing plays a role in the predictability of asset returns.

Style Investing, Mutual Fund Flows, and Return Comovement

Style Investing, Mutual Fund Flows, and Return Comovement

Contagious Capital: A Network Analysis of Interconnected Intermediaries

Existing literature on mutual fund flows documents surprisingly large return effects given that mutual fund flows are uninformed (i.e. not related to fundamentals). I provide evidence that network externalities generate the necessary amplification mechanism to support these results. Network externalities are generated by mutual funds with common holdings and return-chasing investors. Economically, I show that the fund flow network externality is 32-92% as large as the typical explanatory effects (e.g., lagged flows). Network externalities generate a 1.5% quarterly excess return that reverses in the subsequent year, and are independent of style investing and robust to multiple specifications of holdings similarity.

A Comparative Analysis of Performance, Investment Styles,and Risk and Return Associated with Indian Mutual Funds

New financial products, advancements in technology, and restructured financial theories during last two decades have contributed significantly to bringing rapid changes in the global financial markets. The Indian financial sector can be seen extending new horizons of growth with reform processes that were initiated in the 1990s,which show a changing pattern of investors’ investment preferences. The growth of innovative mutual fund schemes has proved to be one of the most catalytic in accelerating the investment growth in Indian capital markets. In addition, Indian markets are waiting to outshine in the area of mutual funds as this particular sector has excellent potential due to the scope of formulating new fund schemes that can be a perfect blend of liquidity, low risk, and higher returns. In an effort to check out the performance of mutual funds in India, this study presents a complete analysis of growth of the various sector mutual funds during the period from 1999 to 2009 and further compares private-sector and public-sector funds in terms of risk and return. The study concludes that although the current perception of investors has changed for private-sector mutual funds, the performance of those funds does not vary much from public-sector funds. Further, the results of the study also prove that private-sector funds do not show any additional risk when compared to private-sector funds. <b>TOPICS:</b>Mutual fund performance, style investing, emerging, risk management

Investment Style and Perceived Drivers of Adoption ofSocially Responsible Investment among SwedishInstitutional Investors

A survey was conducted to investigate investment style and drivers of socially responsible investment (SRI) among institutional investors. Respondents were 60 professionals working as SRI or non-SRI investors in 19 different Swedish banks, pension funds, or mutual fund companies. The results showed that non-SRI investors perceived market regulations to be a strong driver of SRI, while SRI investors perceived others’ behavior to be a strong driver. No differences were found between SRI and non-SRI investors with respect to short-term versus long-term or active versus passive investment styles. <b>TOPICS:</b>ESG investing, style investing, legal/regulatory/public policy

Two Sides of the Coin: Shareholders Engaging Companieson Sustainability Issues/Companies Promoting CSRLeadership as Good Business

There has been tremendous growth in the importance placed by investors and companies on corporate leadership on environmental, social, and governance (ESG) issues. This article discusses the development of this trend as well as business reasons for furthering implementation. This is a trend that does not appear to be changing in the short term. <b>TOPICS:</b>ESG investing, style investing, technical analysis

Style investing and momentum investing: A case study

We examine whether an investor should choose a style rotation strategy (that is style investing) rather than a buy-and-hold strategy or a momentum strategy. We run out-of-sample forecasting/investing horse races between style rotation strategies (based on logit models), simple momentum strategies and buy-and-hold strategies. Regarding style rotation strategies, we consider switches between value and growth indexes, and small-cap and large-cap indexes. To gain a long-term perspective, we use the freely available Fama–French data set, which segments US stocks into value and growth stocks, and small-cap and large-cap stocks. Although the choice of variables to include in the logit models and the investment outcomes depend on the indexes (style switches) under review, our study shows that style switching gives interesting investment results.

A New Investment Style: Featuring an Index ofEntrepreneurial Companies

In these tumultuous times in which investors do not know when or where to place their funds for maximum benefit,one investment index should be considered:Global Entrepreneurs. Our research of 33,000 publicly traded global companies, examined over the past 5+ years, demonstrates that entrepreneurial companies consistently outperform peer non-entrepreneur companies by a wide margin. They perform especially well during periods in which the markets are positive. The investment community now has a new index to track this performance. Is this the start of a new money management style? <b>TOPICS:</b>Mutual fund performance, style investing, global, statistical methods