Volume 19, No. 1, First Quarter 2021

Active Investing and the Efficiency of Security Markets

by: Russ Wermers

This study investigates the impact of active investment management on the efficiency of public security markets. The scholarly literature indicates that active management contributes to market efficiency, thereby providing positive externalities for all investors, including investors in passively-managed funds. Contrary to popular interpretations of Sharpe’s (1991) “active arithmetic,” the benefits of active management are amplified in small and mid-capitalization U.S. stocks, enhancing the ability of these companies to raise capital for investments in the real economy. Across all public corporations, the improved efficiency afforded by active management helps to discipline capital expenditures by corporations through a more efficient stock price.

Investment Style Volatility and Mutual Fund Performance

by: Keith C. Brown, W. V. Harlow and Hanjiang Zhang

We develop a holdings-based statistic to measure the volatility of a fund’s investment style characteristic profile over time. On average, funds with lower levels of style volatility significantly outperform more style-volatile funds on a risk-adjusted basis. We show that style volatility has a distinct impact on future fund performance compared to fund expenses or past risk-adjusted returns, with the level of indirect style volatility being the primary determinant of the overall effect. We conclude that deciding to maintain a less volatile investment style is an important aspect of the portfolio management process.

Lending to Lose: Who Buys Negatively Yielding Bonds and What it Means for Investors

by: Vineer Bhansali

I discuss the demand and supply of negatively yielding bonds, which is a recent and relatively unprecedented phenomenon in financial markets. To understand why one would lend to lose, I classify buyers into three categories, i.e. “forced buyers”, “speculators” and “non-financial government entities”. I conclude that the demand for bonds that are guaranteed to lose money can locally be justified by a variety of rational reasons. However, while locally rational, this conclusion raises important questions about global financial stability. Do negative yields mean that the bond market is distorted due to demand and supply mismatch, and if so what are the consequences if there are unforeseen macroeconomic shocks?

Idiosyncratic Risk and When to Tilt Toward Value

by: Jason D. Fink and Kristin E. Fink

While the outperformance of value relative to growth portfolios has been well established, there is still debate over whether this outperformance is the result of a systematic risk factor or a behavioral tendency. The distinction is crucial to determining the expected returns of value- and growth-tilted portfolios. We find that when idiosyncratic volatility—the key arbitrage portfolio holding cost—increases, the outperformance of value correspondingly increases. Conversely, when idiosyncratic volatility is low, the outperformance is reduced. This is consistent with a behavioral explanation and has important ramifications for the timing of value tilts employed by a portfolio manager.

Comovement, Liquidity and Asymmetries

by: James X. Xiong

Substantially increased institutional investing and index trading in the US stock market have a meaningful impact on the mechanical relationship between return comovement and liquidity, which can be quantified by a power-law function and explained by a liquidity supply model. Three well-documented asymmetries (asymmetric volume, asymmetry in non-market volatility, and positive skewness for individual stocks) are disappearing with increased basket trading, however, asymmetric correlation survives.

Beyond Diversification: What Every Investor Needs to Know About Asset Allocation

by: Sébastien Page • reviewed by: Cel Kulasekaran

“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.

Pairs Trading in the Era of Meme Stocks

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.

Practitioner’s Digest • Vol. 19, No. 1

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.