Volume 20, No. 1, First Quarter 2022

Relevance

by: Megan Czasonis, Mark Kritzman and David Turkington

The authors describe a new statistical method for improving forecasting called relevance. They describe their new method from both a conceptual and mathematical perspective, and they show how relevance links regressions to event studies and machine learning algorithms.

Characteristic-Based Returns: Alpha or Smart Beta?

by: Soohun Kim, Robert A. Korajczyk and Andreas Neuhierl

We propose new methodology to construct arbitrage portfolios by utilizing information contained in firm characteristics for both abnormal returns and betas (and, therefore, smart-beta risk premiums). Our methodology gives maximal weight to risk-based interpretations of characteristics’predictive power before any attribution to abnormal returns. The method allows the explanatory power of a characteristic for both alpha and beta to ebb and flow. This feature is particularly important when we expect that profit opportunities may be arbitraged away by investors. We apply the methodology to a large panel of U.S. stock returns from 1965 to 2018. Empirically, characteristics have time-varying explanatory power for both factor betas and alpha. We find that the arbitrage portfolio has (statistically and economically) significant alpha and annualized Sharpe ratios ranging from 1.31 to 1.66.

Measuring the Economic and Academic Impact of Philanthropic Funding: The Breast Cancer Research Foundation

by: by Detelina Vasileva, Larry Norton, Marc Hurlbert and Andrew W. Lo

Using survey data gathered from grantees of the nonprofit Breast Cancer Research Foundation (BCRF), we investigated the commercial and non-commercial impacts of their research funding. We found significant impact in both domains. Commercially, 19.5% of BCRF grantees filed patents, 35.9% had a project that has reached clinical development, and 12 companies have or will be spun off from existing projects, thus creating 127 new jobs. Non-commercially, 441 graduate students have been trained by 116 grantees, 767 postdoctoral fellows have been trained by 137 grantees, 66% of grantees have used funding for faculty salaries, 93% have achieved collaboration with other researchers, and 42.7% have enacted process improvements in research methodology. Econometric analysis identifies BCRF funding and associated process improvements as key factors associated with the likelihood to file patents. However, we also found that the involvement of more than one institution in a collaborative project had a negative impact on subsequent development. This may point to frictions introduced by multi-university interactions.

How Well Do Factor ETFS Capture the FAMA–French Factors?

by: Nicholas Apergis, Thomas Poufinas, Alexandros Panagakis and Ioannis Ritsios

Institutional investors are investigating systematic, rule-based investment directions other than purely passive investing, such as factor-based investing. This study examines how well the factor-ETFs capture the Fama–French factors and attempts to explain their difference from the smart beta indexes applied in practice. The findings document that the market factor explains a substantial part of the expected returns, with the remaining factors, except momentum, posting smaller or no contribution. Style ETFs exhibit mixed results in capturing their referenced style, with almost all of them exhibiting non-neutral momentum. The findings are of interest to investment managers, investors, risk managers, and stock exchanges.

Exponential Glide Paths

by: Moshe Levy and Haim Levy

In the absence of market-timing ability, investors are better-off keeping their asset allocation constant through time. Target-date funds help reduce variation in the asset allocation, by taking into account that human capital, which is a part of the investor’s total portfolio and is typically considered to be bond-like, diminishes with age. To compensate, target date funds reduce the allocation to equities in the financial portfolio over time. Funds almost universally do so in a linear fashion, following straight-line glide paths. We show that linear glide paths imply two systematic deviations from constant asset allocation, and suggest a simple correction, the exponential glide path. Exponential glide paths lead to a typical increase of 5–22% in welfare relative to linear glide paths.

Practitioner’s Digest • Vol. 20, 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.

In Pursuit of the Perfect Portfolio

by: Andrew Lo and Stephen Foerster • reviewed by: Megan Czasonis

“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.

NFTs as Alternative Investments?

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.