Volume 17, No. 2, Second Quarter 2019

A Portfolio Approach to Accelerate Therapeutic Innovation in Ovarian Cancer

by: Shomesh Chaudhuri, Katherine Cheng, Andrew W. Lo, Shirley Pepke, Sergio Rinaudo, Lynda Roman and Ryan Spencer

We consider a portfolio-based approach to financing ovarian cancer therapeutics in which multiple candidates are funded within a single structure. Twenty-five potential early-stage drug development projects were identified for inclusion in a hypothetical portfolio through interviews with gynecological oncologists and leading experts, a review of ovarian cancer-related trials registered in the ClinicalTrials.gov database, and an extensive literature review. The annualized returns of this portfolio were simulated under a purely private sector structure both with and without partial funding from philanthropic grants, and a public–private partnership that included government guarantees. We find that public–private structures of this type can increase expected returns and reduce tail risk, allowing greater amounts of private sector capital to fund early-stage research and development.

Quantifying the Skewness Loss of Diversification

by: James X. Xiong and Thomas M. Idzorek

Diversification is widely viewed as the “only free lunch” of finance. Unbeknownst to the free lunch crowd, skewness is typically positive for individual stocks and negative for diversified portfolios and thus diversification is not free. This undesirable move from positive to negative skewness that comes with diversification is the skewness loss of diversification. We quantify the economic value of skewness loss using option pricing models, and show that skewness loss is a meaningful cost for investors with skewness preferences and short horizons.

A Model of Bond Value: Explaining Yields with Growth and Inflation

by: Thomas Shevlin

This paper looks to establish a new heuristic for investors, giving them a simple, intuitive way to relate bond yields to prevailing trends in growth and inflation. The model offers an alternative to forecasting surveys, which have been over-estimating 10-year Treasury yields for decades and continue to project yields above 4% in the long run. The model does well in in-sample and out-of-sample tests used in the literature to evaluate other measures of value. The model can be used on its own or in conjunction with other models to forecast yields and also as a benchmark to evaluate yield forecasts. The model is consistent with some of the more advanced economic models of interest rates that suggest that the low bond yields of recent years are in line with broader economic trends, rather than due to temporary factors that are likely to reverse quickly.

Automated Financial Management: Diversification and Account Size Flexibility

by: Michael Reher and Celine Sun

We study the value added of automated financial management (AFM) services along two dimensions: diversification and account size exibility. First, using a company-specific experiment with matched AFM and traditional portfolios, we find that AFM portfolios are significantly better diversified. Underdiversified investors are more likely to set up an AFM account, with a 1 standard deviation increase in underdiversification raising the probability of doing so 3 percentage points. Next, we study account size flexibility using an exogenous reduction in minimum account size. The reduction led to a net increase in total deposit inflows and disproportionately raised new account formation by less-wealthy investors.

Optimal Holdings of Active, Passive and Smart Beta Strategies

by: Edmund Bellord, Joshua Livnat, Dan Porter and Martin B. Tarlie

The growing dominance of the core and explore model — a large passive index combined with a collection of high tracking error satellite portfolios — in conjunction with the growth of factor investing has renewed interest in how to allocate among different equity strategies. We study this problem from an expected shortfall perspective and find that portfolios that minimize expected shortfall differ substantially from portfolios generated using conventional methods.

Using Social Media Analytics in the Management of Investment Management

by: Seoyoung Kim

“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.

The Fifth Risk

by: Michael Lewis • reviewed by: Javier Estrada

“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.

Practitioner’s Digest • Vol. 17, No. 2

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.