JOIM: 2018
Volume 16, No. 1, First Quarter 2018
Environmental, Social and Governance Exposures (ESG)
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Article
Establishing ESG as Risk Premia
This seminal research provides statistically significant evidence for the empirical identification of Environmental, Social and Governance (ESG) as a factor of risk premium when integrated within an equity portfolio. This study purposes to establish that the conceptual development, adoption and population of ESG research-based strategies are leading to the documentation and acceptance of ESG risk premium as an intuitively and measurably independent risk premia. This study has demonstrated empirically, through a cross-sectional analysis of increasingly developed ESG research, that ESG premia geographically and longitudinally provides excess returns. Furthermore, this study presents the potential for ESG premia to take its place alongside other well-documented risk premia such as momentum, volatility, carry, size, value, and liquidity across asset classes.
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Article
A Blueprint for Integrating ESG into Equity Portfolios
Environmental, social and governance (ESG) offers a source of new and potentially valuable information for investors, impacting both potential returns and risk. Growing data availability has created the opportunity to integrate ESG into equity portfolios for a variety of investment processes, for both indexing and active management. In this paper, we provide an overview of the current data landscape and several popular methods for integrating ESG. A main challenge is that ESG data collection and aggregation methods can vary significantly across providers, leading to very different ratings for the same company. If the data issues are properly addressed, integrating ESG has important potential benefits for investors. Our “blueprint” lays out a path for any investment manager seeking to understand how ESG fits into their investment process.
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Article
Carbon Footprint and Productivity: Does the “E” in ESG Capture Efficiency
This paper analyses the now-popular carbon ratio (emissions relative to sales) as a way to select stocks. We document that reduced carbon ratios are associated with stronger future profitability and positive stock returns in a global universe of stocks. But why? The prevailing view is that lower emissions reduces a firm’s exposure to future greenhouse gas regulations or taxes, and the market is slow to appreciate this. However, we find strong effects in industries such as internet and commercial services where carbon taxes would have little direct effect. We show that there is a more fundamental connection between carbon emissions and overall productive efficiency. Most of a firm’s activities, or inputs, result in some form of carbon emission due to direct energy consumption or indirect emissions (e.g., travel). We first show evidence that carbon emission works like an input to production along with the more traditional capital and labour. More importantly, firms that produce more than expected given their inputs tend to outperform in the future both in profitability and returns.
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Book Review
Portfolio Construction, Measurement, and Efficiency Essays in Honor of Jack Treynor
“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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Practitioner's Digest
Practitioner’s Digest • Vol. 16, 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.
Volume 16, No. 2, Second Quarter 2018
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Insight
Complete and Incomplete FinTech Platforms
A major consequence of the Internet era is the emergence of complex “platforms” that combine technology and process in new ways that often disrupt existing industry structures and blur industry boundaries. These platforms allow easy participation that often strengthens and extends network effects, while at the same time the vast amounts of data captured through such participation can increase the value of the platform to its participants, creating a virtuous cycle. While initially slow to penetrate the financial services sector, such platforms are now beginning to emerge.We provide a taxonomy of platforms in finance and identify the feasible strategies that are available to incumbents in the industry, innovators, and the major Internet giants.
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Article
Common Factors in Corporate Bond Returns
We find that four well-known characteristics (carry, defensive, momentum, and value) explain a significant portion of the cross-sectional variation in corporate bond excess returns. These characteristics have positive risk-adjusted expected returns and are not subsumed by traditional market premia or respective equity anomalies. The returns are economically significant, not explained by macroeconomic exposures, and there is some evidence that mispricing plays a role, especially for momentum.
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Article
Evaluation and Ranking of Market Forecasters
Many investors rely on market experts and forecasters when making investment decisions, such as when to buy or sell securities. Ranking and grading market forecasters provides investors with metrics on which they may choose forecasters with the best record of accuracy for their particular market exposure. This study develops a novel ranking methodology to rank the market forecaster. In particular, we distinguish forecasts by their specificity, rather than considering all predictions and forecasts equally important, and we also analyze the impact of the number of forecasts made by a particular forecaster.We have applied our methodology on a dataset including 6627 forecasts made by 68 forecasters.
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Article
The Dirty Dozen of Valuation Ratios: Is One Better Than Another?
This paper compares the efficacy of both traditional valuation ratios and an extensive set of related combination criteria in identifying the future best-performing stocks for a comprehensive U.S. sample over the period 1971–2013. Value portfolios formed on different criteria have remarkably different exposures to style factors. We find evidence of strong relative efficacy of three enterprise value multiples (EBIT/EV, EBITDA/EV, and S/EV). Particularly, the evidence for the unique characteristics of S/EV contributes to the existing literature. The defensive characteristic of high dividend yield is pervasive both as a stand-alone criterion and as a combination sub-criterion.
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Book Review
A Practitioner’s Guide to 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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Practitioner's Digest
Practitioner’s Digest • Vol. 16, 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.
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Article
Crypto-Assets Unencrypted
With the recent surge in crypto-activity, a natural question arises as to what exactly a “cryptocurrency” is and how to value and assess these digital assets. In this paper, we provide an overview of the history and technology underlying cryptocurrencies. We also present information on the volume, size, and volatility of this emerging asset class, which we compare to major fiat currencies and commodities. Finally, we provide a framework for valuing crypto-assets, discuss the still-evolving regulatory environment for this asset class, and discuss the mechanics of investing in cryptocurrencies.
Volume 16, No. 3, Third Quarter 2018
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Article
A New Approach to Goals-Based Wealth Management
We introduce a novel framework for goals-based wealth management (GBWM), where risk is understood as the probability of investors not attaining their goals, not just the standard deviation of investor’s portfolios. Our framework is based on a foundation of developments in behavioral economics and finance and is consistent with modern portfolio theory. Using a simple geometric analysis, we determine a specific portfolio that matches each individual investor’s stated goals. Our approach requires information from the investors about their goals, elicited in a clear manner that market research shows is superior to common current practices. This new approach can improve the communication between advisors and clients and produce better advice for enabling clients to attain their goals with high probability through the use of efficient portfolios.
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Article
Defined Contribution Pension Plans and Mutual Fund Flows
Defined contribution (DC) pension plans constitute an important component of mutual fund assets. Flows into DC plans depend on the decisions of plan sponsors and plan participants: The sponsors select the investment menus made available to employees and the participants decide how to allocate their retirement savings across the investment options.We examine the flows to mutual funds within DC pension plans and contrast these flows with flows from other mutual fund clienteles. We find that flows into funds from DC plans exhibit more performance sensitivity than do flows from non-DC investors.
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Article
Picking Through the Alpha Graveyard Correcting for Survivorship Bias in Investment Product Universes
The authors propose a practical technique to correct for survivorship bias across return distributions for investment product universes. The technique is designed to work efficiently in a large-scale performance measurement environment. It uses all available data for survivors and non-survivors, corrects for bias across the full distribution (from 1st to 99th percentile), and can be applied to other return-based statistics such as Sharpe ratio, standard deviation, and correlation. The technique is applied to a variety of product universes over a 10-year period to highlight the practical ways that it can be used to improve the investment decision-making process.
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Survey & Crossover
Distributed Ledger and Blockchain Technology: Framework and Use Cases
Since its first widespread implementation in 2009, distributed ledgers in general, and blockchain technology in particular, have rapidly become a part of the FinTech vernacular. In this paper, we provide an overview of the history of trade settlement and discuss this nascent technology that may now transform traditional methods of verifying and settling transactions. In so doing, we discuss current and potential use cases of this technology and provide a business-oriented framework for proper as well as improper implementations and applications of blockchains and distributed ledgers.
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Book Review
Adaptive Markets: Financial Evolution at the Speed of Thought
“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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Practitioner's Digest
Practitioner’s Digest • Vol. 16, No. 3
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.
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Article
Macro-Based Parametric Asset Allocation
Without doubt the financial returns of asset classes are interlinked with the economy. However, a direct link between financial returns and return-driving forces has not been discovered yet. Moreover, there exist many robust approaches for within-asset-class allocation but few advances have been made for between-asset-class allocation. To address these topics I propose a direct modeling of the weights with macroeconomic risk factors. This allows to implicitly identify capital-market dynamics and thus provides a framework which can help in the tactical asset allocation decision.
Volume 16, No. 4, Fourth Quarter 2018
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Article
Explaining the High P/E Ratios: The Message from the Gordon Model
Are the high valuation levels of equity prices, after controlling for the low interest rate level, driven by irrational exuberance and excessive growth expectations? The Gordon model helps for a consistent interpretation of commonly used valuation ratios. Overall, P/E ratios do not seem to be caused by irrational growth expectations, rather a decline can be observed over the past years. Discount rates are the major drivers of high valuation levels in Europe and particularly in Switzerland, while profitability is the major source in the US and Germany.
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Article
Time Aggregation of Sharpe Ratio A Better Extrapolation Rule
The √T rule extrapolates a one-period Sharpe Ratio to T periods. But the rule ignores compounding. By considering compounding, Levy (1972) and others show that the Sharpe Ratio changes non-monotonically with horizon. We also theoretically and empirically show that the Sharpe Ratio term structure is hump-shaped and not upward sloping as the √T rule suggests. We offer a better extrapolation rule. Using bootstrapped Generalized method of Moments (GMM), we provide robust Sharpe Ratio estimates of several popular test assets. The empirical results reject the √T rule over a long horizon.
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Article
Trading Methods and Trading Costs for Agency Mortgage-Backed Securities
Investors can trade individual agency mortgage-backed securities (MBS) as specified pools (SPs), or trade them through TBA forward contracts. Sellers in the TBA market deliver the cheapest possible pool that fulfills the contracts, so they are traded on a cheapest to deliver basis. More valuable mortgage-backed securities are traded as SPs. We show that trading costs are far, far lower for TBA trades. Trading costs are lower for large trades, for trades with more active dealers, for trades of MBS with a large balance outstanding, and for trades where dealers act as brokers rather than commit capital.
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Article
Automation, Intermediation and the Flash Crash
The Flash Crash of May 6, 2010, shook the confidence of market participants and raised questions about the market structure of electronic markets. In these markets, intraday intermediation has been increasingly provided by market participants without formal obligations to do so. We examine intraday intermediation in the E-mini S&P 500 stock index futures market before and during the Flash Crash. We also discuss the evolution of trading from human to electronic environments and the implications of our results for market design.
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Article
Illiquidity and Factor Returns: Exploring the Intersection Between Illiquidity, Small Cap and Popular Factors
Factor returns are often reported as the average of factor returns among large stocks and the factor returns among small stocks. However, factor returns among small, illiquid stocks are significantly higher than those among larger, more liquid stocks, suggesting that the factor returns in the literature are exaggerated and cannot be implemented with substantial assets. Moreover, investors who are able to take greater liquidity risk can capture higher factor returns by investing in factors among small stocks.
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Book Review
The End of Theory
“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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Practitioner's Digest
Practitioner’s Digest • Vol. 16, 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.
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Survey & Crossover
Risk, Reward, and Beyond: On the Behavioral Sensitivities of Mean–Variance Efficient Portfolios
“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.