Volume 13, No. 4, Fourth Quarter 2015
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Article
Funding Translational Medicine via Public Markets: The Business Development Company
A business development company (BDC) is a type of closed-end investment fund with certain relaxed requirements that allow it to raise money in the public equity and debt markets, and can be used to fund multiple early-stage biomedical ventures, using financial diversification to de-risk translational medicine. By electing to be a “Regulated Investment Company” for tax purposes, a BDC can avoid double taxation on income and net capital gains distributed to its shareholders. BDCs are ideally suited for long-term investors in biomedical innovation, including: (i) investors with biomedical expertise who understand the risks of the FDA approval process, (ii) “banking entities,” now prohibited from investing in hedge funds and private equity funds by the Volcker Rule, but who are permitted to invest in BDCs, subject to certain restrictions, and (iii) retail investors, who traditionally have had to invest in large pharmaceutical companies to gain exposure to similar assets. We describe the history of BDCs, summarize the requirements for creating and managing them, and conclude with a discussion of the advantages and disadvantages of the BDC structure for funding biomedical innovation.
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Case Study
Male Life Expectancy Graph
“Case Studies” presents a case pertinent to contemporary issues and events in investment management. Insightful and provocative questions are posed at the end of each case to challenge the reader. Each case is an invitation to the critical thinking and pragmatic problem solving that are so fundamental to the practice of investment management.
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Book Review
Portfolio Management Under Stress: A Bayesian-Net Approach to Coherent Asset Allocation
“Book Reviews” identifies important, and often popular, new books from a wide range of investment topics. Beyond providing a summary and review of the content and style of the books, “Book Reviews” seeks to contribute to a conscious, critical, and informed approach to investment literature.
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Article
Is U.S. Insider Trading Still Relevant? A Quantitative Portfolio Approach
For 40 years academic literature has reported statistically significant excess returns to selected insiders trading in their firms’ shares, and similar evidence for outsiders who selectively mimic insider trading decisions spans three decades. However, constructing tradable signals leveraging insider trading data is challenging due to the irregular frequency of trades. We report that carefully constructed insider trading signals continue to produce statistically significant excess returns in US equity markets. We combine an insider factor with a non-insider stock selection model that is itself statistically significant and report economically meaningful incremental returns. The combined model is robust to different portfolio optimization techniques.
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Article
Investing in the Asset Growth Anomaly Across the Globe
We document the existence of an anomalous asset growth effect globally and find that it comprises some combination of a market mispricing and some pervasive global systematic risk. To support our findings, we explore a battery of tests to include how country-level governance and market characteristics explain the cross-country differences in the effect. We also find evidence that any profits to a trading strategy based on the asset growth effect globally are reduced, though not eliminated, by arbitrage costs.
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Article
Efficiently Combining Multiple Sources of Alpha
In this article, we examine the question of efficiently combining multiple sources of alpha. We begin with a comparison of the various methods used by practitioners for constructing portfolios that capture a single alpha signal. These methods are broadly categorized as either: (a) simple factor portfolios, (b) pure factor portfolios, or (c) minimum-volatility factor portfolios. We then derive an equation that shows the optimal alpha weights given the expected returns and covariance matrix of the alpha signals.We provide a discussion on how the required inputs can be estimated in practice, and conclude with an empirical example to illustrate these effects.
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Article
Fundamental Indexation and the Fama-French Three Factor Model: Risk Assimilation or Stock Mispricing?
We confirm the outperformance of fundamental indexation (FI) portfolio returns as due to an exploitation of stock mispricing, while, simultaneously, largely explained in terms of the Fama–French three-factor (FF-3F) model. This leads us to conclude that rather than FI representing a repackaging of the book to market and small firm size effects as encountered in the FF-3F model, the impact of these factors in the FF-3F model is explained by their ability to differentiate on aggregate between over- and under-priced stocks.
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Insight
Limits on the Level of Demand a Country Can Afford
With home goods (e.g urban services) output equals demand; when demand increases we put older machines back to work. But the real wage depends on the productivity of the marginal home goods plant. Because money prices go up when the real wage goes down, an increase in demand is inflationary.
On the other hand, with tradable goods (e.g., commodities), an increase in demand results in virtually no increase in local output, hence in an almost equal increase in the trade deficit.
In both cases, a failure to invest in plant capacity results in an increase in demand the country can’t afford.