Volume 14, No. 4, Fourth Quarter 2016

New Look at Discount Returns: Implications for the Global Investor

by: Anthony Tessitore and Nilufer Usmen

This paper examines risk–return characteristics of discount returns on portfolios of closed end funds and how they might benefit investors. Discount return is defined as the percentage change in discounts over a period. This paper focuses on the distribution of discount returns conditioned on discount level rather than time. Discount returns characterized this way represent an income stream that has little correlation with other well-known asset class and style-based factors. This paper shows that by adding discount portfolios to a traditional asset allocation mix an investor can improve diversification and earn higher risk-adjusted returns.

After-Tax Portfolio Value: The Missing Tax Option

by: Andrew Kalotay

After-tax performance measurement requires a rigorous definition of after-tax portfolio value, which is also a prerequisite for effective portfolio management.

The focus of this paper is the tax option, which is the right to execute tax-beneficial transactions. This option is a critical component of after-tax portfolio value. Some of the proposed definitions incorporate the intrinsic value of the tax option. However, the time value of the option has not been explicitly considered previously. Incorporating the time value of an option is in line with contemporary finance theory, and it provides a more accurate assessment of after-tax value. The tax option can be valued using standard models appropriate to the asset under consideration, but incorporating investor-specific parameters such as tax rates and mortality rates.

Mean Variance Optimization with Public and Private Asset Classes

by: Yu (Ben) Meng, Pu (Paul) Zhang and Ryan Ong

Liquidity has long been of great interest to investment professionals as well as academic researchers. The estimation of the illiquidity premium for infrequently traded asset classes, such as real estate and private equity, presents a challenge to the industry because of opaque information and sporadic trading activities. We propose using the autocorrelations of returns as a tool to estimate the transaction costs and illiquidity premium of private assets. This tool can also be used to adjust the risk of illiquid asset classes. At the end of this article, we show through an example that after making these adjustments to the estimates of expected return and risk, private and illiquid assets can be reasonably compared with public and liquid assets in the standard mean–variance optimization (MVO) process.

Can Fundamental Factors Enhance the Performance of Traditional Momentum Strategies?

by: Susana Yu and Gwendolyn Webb

We test whether price-based momentum strategies can be improved by additional screening based on fundamental measures.Within the framework of portfolio formation based on recent winning or losing stocks, we further screen on the basis of fundamental measures of financial strength and gross profitability. Our key results are that the performance of long–short, price based momentum strategies can be significantly improved when either fundamental measure is employed as a second screen. Of these two measures, the more effective appears to be gross profitability. These results support the hypothesis that fundamental financial information can be used by investors to improve portfolio performance.

God’s Own Arithmetic: Harry Markowitz’ Risk-Return Analysis

reviewed by: Craig W. French

“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.

The Economics of Flash Orders and Trading

by: Lawrence E. Harris and Ethan Namvar

“Surveys& Crossovers” This section provides surveys of the literature in investment management or short papers exemplifying advances in finance that arise from the confluence with other fields. This section acknowledges current trends in technology, and the cross-disciplinary nature of the investment management business, while directing the reader to interesting and important recent work.

Practitioner’s Digest • Vol. 14, No. 4

The “Practitioners Digest” emphasizes the practical significance of manuscripts featured in the “Insights” and “Articles” sections of the journal. Readers who are interested in extracting the practical value of an article, or who are simply looking for a summary, may look to this section.