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"The realities of economics are the subject of this memo. Central bank actions can encourage or accelerate economic activity, but they can’t create economic activity that otherwise wouldn’t occur. So far, as the last seven years show, (a) central banks haven’t been able to generate the growth they hoped for and (b) the impact of each successive jolt of stimulus seems to have been less powerful. Fundamental improvements – intelligent changes in investment incentives, the tax system or infrastructure, for example – can increase the slope of the growth curve and provide substantial net long-term benefits for a society (although not necessarily for every individual member). Short-term fixes simply cannot create wealth out of thin air."
Read the paper: Economic Reality (May 2016)
"India’s hour on the global macroeconomic stage has arrived. Investors should take notice. In 2015, India formally assumed the mantle of the world’s fastest-growing large economy thanks to returns on investment that are 2.5x the global average. With effective wages one-tenth of the U.S. level, a capital stock one-third the size of China’s, and a large pool of underemployed labor, India could absorb a significant increase in fixed investment with no diminution in returns. Unlike in China, which suffers from industrial overcapacity and declining returns on incremental capital, India faces no similar constraints on future growth. The messiness of democratic politics should not distract investors from the strength of the Indian economy’s underlying momentum."
"UK voters have often been reluctant Europeans. UK voters will decide in June if the country will stay in the European Union (EU) or exit the bloc. Two key issues dominate the headlines on the Brexit debate: the economy and immigration. A leave vote would immediately usher in a period of acute
political and economic uncertainty for the UK – and to a lesser extent for the rest of the EU. We see a Brexit vote having a large and negative economic impact in the near term – and meaningful implications in
the long run. Our overarching view from an investor’s perspective: the likely negative impact on the UK economy is more concrete than any speculative long-term positives."
Read the paper: Brexit: Big Risk, Little Reward (February 2016)
"Impressive past results for so-called smart beta strategies, even if only on paper, are attracting enormous inflows. [But] is the financial engineering community at risk of encouraging performance chasing, under the rubric of smart beta? If so, then smart beta is, well, not very smart. Anomalies and factor returns tend to appear and then fade, depending on recent performance. Value-add can be structural (hence, plausibly a source of future alpha) or situational (a consequence of rising enthusiasm for, and valuation of, the selected factor or strategy). [Our] evidence suggests that mean reversion could wreak havoc in the world of smart beta. Many practitioners and their clients will not feel particularly “smart” if this forecast comes to pass."
Read the paper: How Can "Smart Beta" Go Horribly Wrong? (February 2016)
"Is high yield debt cheap today? There is no particularly easy answer to this question given the nature of high yield, but the short answer is “probably” with a strong suspicion
that it is not worse than fair value. In an environment where very few assets around the world are even particularly close to fair value, that statement seems like a pretty strong endorsement. We are not yet leaping into high yield with both feet, however, for a couple of reasons. First, our suspicion is that we are likely entering a new “default cycle” where default rates
on high yield bonds rise above long-term averages. And second, there are a number of features of the high yield market that indicate it is particularly likely to overshoot fair value as defaults rise."
Read the paper: Giving a Little Credit to High Yield (January 2016)
"'Quality' is arguably one of the most overused terms in the investment industry. [There] is no single, universal definition of 'Quality'. The concept is subjective and multi-faceted. Ultimately, Quality is about the confidence in a company’s ability to grow and thrive in an uncertain future. [It] is interesting to see that High Profitability and Low Leverage are the two most commonly used Quality criteria by asset managers... One reason is that they are reasonably easy to measure. The other is that it makes sense... In this environment, Quality becomes a much sought after attribute. Holding Quality assets – regardless of the asset class - is the best way to protect one’s capital."
Read the paper: The importance of Quality today (February 2016)
"This paper attempts to show why the proponents of sound finance are mistaken by defining and unpacking a series of “myths” that are foundational to, or at least helpful to, convincing us that sound
finance requires that governments run a balanced budget. Perhaps the foun-dational myth of all believers in sound finance is that the government sector is just
like a household. Once one understands that the government deficits are the counterpart to private sector savings, then
concepts such as the national debt take on a different hue. A move away from the obsession with monetary policy potentially could help generate a return to a more normal world from a valuation perspective."
Read the paper: Market Macro Myths:
"The monetary policy cycle has dominated financial markets for years. As the global
liquidity wave crests, the business, credit and valuation cycles should gain in
importance. Unusually, these cycles appear to be out of sync. This argues for careful
navigating in 2016. China’s economic deceleration and shift to a consumer-driven economy are putting the brakes on the global business cycle. The knock-on effects of movements in oil prices and the U.S. dollar are critical. Long-term trends such as aging populations, high debt loads and technological change are intersecting with short-term cycles. This means the high growth rates of the past may not return."
"In 2015, we saw old problems get worse, new ones arise, and a general absence of anything to feel good about. In August, the events in China sparked a revival of risk aversion and fear... And with the door opened to fearful interpretation, Pollyanna tolerance gave way to widespread negativism. [Investors'] optimism has deflated a bit, some negativity has come into the equation, and prices have moved lower. Depending importantly on which markets we're talking about and how it has fared in recent months, we consider it appropriate to move forward with a little less caution. The bottom line for me is that a rerun of the Global Financial Crisis isn't in the cards...."
Read the paper: On The Couch (January 2016)
"Over the past three months, uncertainty over the course of Chinese development has intensified, with a steady flow of mostly bad economic news... The reality is that China is staring economic stagnation in the face, and the ruling Chinese Communist Party (CCP) is panicking. Saying that China's rise is ending is not the same as saying the country will collapse. The value of Chinese assets has surely been exaggerated by excessive monetary growth, but China is still the 2nd wealthiest country in the world in aggregate terms and is a formidable military power. Probably sooner rather than later, the party will face challenges to its political legitimacy, which will be hammered by the end of the economic rise."
Read the paper: The End of China's Rise (January 2016)
"Many commercial index providers aim to obtain strong exposure to risk factors through a stock selection that is often restrictive, resulting in relatively few securities in the portfolio in terms of the nominal number of stocks. Moreover, the weighting scheme applied to the stock selection is either market cap-weighting or score-based weighting, resulting in a very uneven distribution of weights. As a
result, these indices are often very concentrated in a few stocks. [The] the
question of diversification is key for smart beta offerings. [Factor] concentration has led many factor indices holding Volkswagen AG... to ultimately incur definite losses in the month of September 2015."
Read the paper: The Limitations of Factor Investing (October 2015)
"Some investors seem to fall into the logic trap of equating high Active Share (AS) with an automatic expectation of future outperformance. ...the probability that results will differ from a benchmark... just means the likelihood is greater that a portfolio will either materially outperform or underperform its index before fees. What is high AS? In this paper, we show that the construction of the benchmark index does set conditions and may impose practical limitations for AS. Therefore, from this relative perspective, there is no universal answer to whether a specific level of AS is high or low. AS varies across differing universes, and varies most with capitalization..."
"The student housing market has come
of age... Rapid wealth creation in emerging economies has led to a surge of globally mobile students seeking quality education overseas and, in turn, a place to stay. For many host countries, the purpose-built student housing sector has consequently become established as a highly-investible asset class. Growing demand is set alongside very low levels of supply in many markets, making student housing a secure and appealing investment. Performance in the sector has low correlation to the traditional real estate asset classes, so it has proved particularly effective in diversifying property portfolios."
Read more: World Student Housing (October 2015)
"I’m constantly intrigued by the parallels between investing and sports. For most participants, success is likely to lie more dependably in discipline, consistency and minimization of error, rather than in bold strokes – high batting average and an absence of strikeouts, not the occasional, sensational home run. Consistency and minimization of error are two of the attributes that characterized Yogi’s career [a catcher on New York Yankees baseball teams], and they can also be key assets for superior investors. But in order to be superior, a player has to do something different from others and has to have an appropriate level of confidence that he can succeed at it."
"The current market selloff and spike in volatility is largely attributed to developments in China and uncertainty about the impact of expected Fed hikes. However, much of the Equity trading in the last few days was done by systematic investors that don’t rely on fundamentals.
In the current environment these investors areselling equities and will negatively impact the market over the coming days and weeks. Trend Following strategies (CTAs), Risk Parity portfolios, and Volatility Managed strategies all investing in equities based on past price performance and volatility. The obvious risk is if these technical flows outsize fundamental buyers."
"Investors still consider ESG as a ‘nice to have’ on the whole. Less than half (46%) of
investors [we surveyed] believed companies that focus on ESG issues produce better long-term returns for investors. ESG is clearly being regarded more as a risk to be mitigated, rather than as a positive driver of investment performance. The lack of importance attributed to ESG factors stems largely from
the obsession in the investment management industry with
performance measurement. Investment decisions should be about outcomes that are not purely nominal...
"The quantitative easing (QE) programs in America, Europe and Japan have driven investors up the risk curve via ultra-low yields. These have not only distorted asset valuations, they have also marginalized the navigation tools that investors have
long relied on, such as risk-free rate, fair valuation and equity risk premium. As a result, investors are on a journey into the unknown where value traps are just as likely as value opportunities. [Investors] are forced to act contrarian in this age of near-zero yields, where assets are so
mispriced and their risks so obscure. Outcome-oriented investing is here to stay, as is the rise of its analogue — multiasset
Read more: Survival of the Fleetest (September 2015)
"The China growth story is now broken. The human reaction to a broken story is an emotional response akin to a sudden loss of faith. The belief system around [Emerging Markets] has been crumbling...since the summer of 2013. I see little weakness in either the US growth story...or the Narrative of Central Bank Omnipotence. ...I'll be much more nevous if the China political competence story continues to deteriorate. ...if the competency story breaks the result is always a very dicey and usually a violent power transition... [It] certainly bears close watching."
Read more: The Story is broken (August 2015)
"The plunge in Chinese equities since mid-June, and the extraordinary measures taken by the government to arrest that decline, have raised doubts about the country’s financial stability and the strength of China’s real economy. In both cases, we expect the stock market correction to have a limited impact, reflecting the modest role that equities play in the portfolios of Chinese households. However, Beijing still faces a difficult balancing act: keeping real economic growth close to its 7% target rate, while slowing credit growth to something more in line with nominal economic growth."
"Everybody involved in the credit markets wants to know when the cycle will turn. Today, many credit strategists point to the relative lack of near-term high-yield maturities as a reason for investors to be constructive on credit. Our point is simply that, based on the experience of the last three credit cycles, there seem to have been much larger forces at work that ultimately caused credit spreads to widen and default rates to spike. From the perspective of an investor trying to formulate a high-yield outlook, it seems to us that focusing too much on the maturity wall is probably unhelpful."
"Factor investing has emerged as the new paradigm for long-term investment. Our results suggest that this form of investing is the best strategy when short sales are permitted. It also outperforms industry-based allocation during expansion and bull periods. This paper [compares] the financial performances of factor-based and
industry-based asset allocations. The investment universe is composed of large and mid-cap U.S. equities. Overall, we show that factor investing is worth attracting the attention of investors with low to moderate risk aversion."
"We have a dual objective today, to define and then demystify the issue that is alternative beta. With the proliferation of factors...what we see is, there's no dominant factor through time. It is really hard to understand within one fundamental portfolio, or quantitative portfolio, what are the exposures you already have versus what you are trying to accomplish specifically with one specific factor exposure. So understanding that there is no dominant factor... we think about diversifying, because diversifying can reduce volatility, reduce downside, and lead to better risk-adjusted performance over time."
"A necessary condition for long-term outperformance is that the actively managed portfolio is substantially different than the benchmark... We find that among high Active Share portfolios only those with patient investment strategies are able to outperform their benchmarks on average. [Their] outperformance can largely be explained by their focus on stocks that other investors shun or find less attractive for their impatient strategies: picking safe (low beta), value... and high quality stocks and then sticking with those over relatively long periods."
"Depending on how we measure alphas, a one percent increase in inflows leads to a 0.42% to 0.82% decrease in the odds of a positive change in alphas, whereas a one percent increase in outflows is associated with a 0.86% to 1.34% increase in the odds of an increase in alphas. We find that lagged changes in size, instrumented
by predicted flows, are strongly related to changes in mutual fund performance. Thus, flows are an important factor behind the lack of predictability in mutual fund performance."
"As Bernanke explains, '…the equilibrium interest rate is the real interest rate consistent with full employment of labor and capital resources, perhaps after some period of adjustment.' I’ll content myself here by highlighting [that equilibrium interest rate] simply doesn’t fit the way the world actually works. The reality is that there is no market for “real” capital, and there never has been such a market. It is scary to think that this is the topic that central bankers are debating."
Read more: The Idolatry of Interest Rates (May 2015)
"Using data from 1980-2014, our study showed that over the long term, the value premium was evident across valuation metrics, regions, and market capitalizations. The value premium for U.S. large-cap stocks was the lowest among all segments. Small-cap stocks exhibited a higher value pemium than large-cap stocks for U.S. and non-U.S. markets. On the contrary, within emerging markets, the value premium was higher for large-cap stocks than it was for small-cap stocks."
"The standard narrative is that a U.S. rate hike draws investors to the U.S. because of higher rates on dollar deposits. Asian local currency bonds are sensitive to changes in both global and local rates. Historically, Asian local currency bonds have been more sensitive to the particulars of their national economies and monetary policies. A rise in the U.S. short rate does not necessarily result in higher rates anywhere along an Asian yield curve. Asian fixed income is more strongly tethered to changes in local policy rates, and less so by global rates. [A] key difference this time is that the U.S. and Asian economies are on different growth and monetary policy trajectories."
"The problem with current low bond yields is that the potential for a further decline in yields is lower because rates cannot fall much further, limiting the potential for their
prices to increase and hence provide protection during such shocks. This dislocation, mainly driven by exceptional central bank policies (together with the
exceptional situation on inflation), leads to an unusual negative skew in the distribution of bond returns. In simple terms, when bond yields cannot fall further, they can only stabilise or rise, leaving the investor with a highly asymmetric payoff. Given the current level of yields, investors should accordingly diversify their sources
MFS International Ltd.
"Culture is at the heart of competitive advantage today; this is particularly
the case for investment firms where people and their judgments are the chief assets. The culture of a firm sets the stage for how investors work in teams and collaborate with their colleagues to make
investment decisions. A team-oriented culture can be very helpful in mitigating behavioural biases, such as anchoring and confirmation bias. Another benefit of a collaborative culture is that the diversity
of viewpoints help investors sift the signals from the noise. In sum, we argue that a strong culture in investment management firms is a requirement for sustainable
The Brandes Institute
"We must bow to the inevitable - we cannot precisely predict the behaviour of future liabilities nor capital market returns. One of the biggest problems with investing is the presumption that any market, [..] can be divided into just nine categories that will capture the entire market's risk/return profile. Nine-box investing add complexity to an investment structure and can leave large holes in the portfolio. The key is making portfolios that are sturdy and ensure liabilities are being funded. The key to success is not attempting to avoid volatility and reaching for shorter-term gains. [The] values of clarity and transparency outweigh the limited benefits of [...] quantitative structures..."
Jenkinson et al.
"Using [1999-2011] survey data from consultants, we find... consultants’ recommendations are driven partly by the past performance of fund managers, but more so by non-performance factors, suggesting that consultants’ recommendations do not merely represent a return-chasing strategy. Second, we find that investment consultants’ recommendations have a large and significant effect on institutional asset allocation. Third, we find no evidence that consultants’ recommendations add value to plan sponsors. On an equal-weighted basis, the performance of
recommended funds is significantly worse than that of non-recommended funds."
"Combining insight from active share and
portfolio concentration with tracking error
can help investors identify managers that
may be better poised for success, with
both a better distribution of outcomes and
a better average outcome. Our findings for institutional managers over the most recent market cycle are directionally consistent with those of Cremers and Petajisto’s study of mutual funds over multiple cycles.
[Investors] that select higher active share managers may experience better returns.
Most active portfolios are probably overdiversified. Our findings suggest
there is merit to the intuition connecting
managers with more concentrated portfolios to increased chances for outperformance."
"Humans have a deep-seated desire to anticipate the future. The key to superforecasters is how they think. They are actively open-minded, intellectually humble, numerate, thoughtful updaters, and hard working. Super-forecasters tend to be comfortable with a sense of doubt. Rather than looking at all aspects of the world through a single lens, good forecasting requires considering multiple points of view. The first step in coming to useful answers is to ask good questions. A good question has a clear outcome within a specified period of time and addresses an issue that is relevant to the world. Questions must also have a set time frame. Finally, good questions are also relevant. ...thinking is an important precursor to action."
Read the paper: Sharpening Your Forecasting Skills (September 2015)
Kohlberg Kravis Roberts & Co.
"Despite the recent sell-off in risk assets, we still do not think that 2016 is the time to lean in. Our base case is that the investment climate remains a time for 'Adult Swim Only.' [There] is the potential for the really slow nominal GDP growth environment to continue to exert significant downward pressure on revenues, despite upward pressure on labor costs. [We] see China's slowdown in growth as structural - not cyclical. So, whar are the implications of a below consensus nominal GDP and nominal revenue environment? First is that investors are likely to pay lower multiples, on average, when the macro backdrop includes a low inflation/disinflationary environment. [Focus] areas... parts of healthcare, value-added technology and consumer experiences...."
Read the paper: Spotlighting 2016's Great Debates (March 2016)
Thornburg Investment Management
"Empirical results show ESG investing not only lives up to the performance of conventional fund benchmarks, but that it has the potential to outperform them. One-hundred percent of the academic studies analyzed showed that companies with higher ESG ratings have a lower cost of capital of both debt and equity. Of those companies, 89% exhibited a market-based
outperformance and 85% accounting-
based outperformance. Adherence to ESG factors can have a direct, positive impact on the momentum and profitability of business models. Emphasizing positive selection criteria over negative screens is why sustainable investing is breaking away
from the pack."
Read the paper: Sustainable Investing as Performance Investing (January 2016)
University of Chicago
"In this paper, we document a form of excess volatility in term structure prices that
is irreconcilable with "standard" asset pricing models. Our central finding is that price fuctuations at different points in the term structure are internally inconsistent with each other; prices on the long end of the term structure are far more variable than justified by the behavior of short end prices given usual modeling assumptions. [Excess] volatility of long maturity prices is evident in a large number of asset classes, including claims to equity and currency volatility, sovereign and corporate credit default risk, and inflation. ...[Excess] volatility puzzle,cannot be fully resolved by rational variation in discount rates."
Read the paper: Excess Colatility: Beyond Discount Rates (October 2015)
John C. Bogle
"Mutual fund investors... have come to accept the value proposition offered by indexing. The fundamental principles established by [Vanguard's] first index fund are simple: Buy virtually the entire
US stock market and hold it intact “forever,” eliminate advisory fees, and minimize both operating costs and portfolio turnover. These simple principles
have won the day. But what would it take to persuade the members of Vanguard’s board of directors—conservative to
a fault—to approve an unprecedented innovation? Two strong pillars supported moving my concept of indexing from vision to reality. The first pillar was intellectual support. The second pillar was analytical support."
Read the paper: The Index Mutual Fund: 40 Years of Growth, Change, and
"'Flexibility' will be key to success in the Fourth Industrial Revolution - economies with the most flexible labor markets,
educational systems, infrastructure, and legal systems are likely to be relative beneficiaries. The Fourth Industrial Revolution is being driven by extreme
automation and extreme connectivity. We expect developments in extreme auto-mation and extreme connectivity, blended in AI solutions, to have a significant
impact on the nature of knowledge work... The Fourth Industrial Revolution
is expected disproportionally to benefit developed markets at the expense of emerging markets, at least given current
Read the paper: Extreme automation and connectivity... (Janaury 2016)
City University London
"We examine the effectiveness of applying a trend following methodology to global asset allocation between equities, bonds, commodities and real estate. The application of trend following offers a substantial improvement in risk-adjusted performance compared to traditional buy-and-hold portfolios. We also find it to be a superior method of asset allocation
than risk parity. We believe the discipline of trend following overcomes many of the
behavioural biases investors succumb to, such as regret and herding. We observe that a flexible asset allocation strategy that allocates capital to the best performing instruments irrespective of asset class enhances this further."
Read the paper: The Trend is Our Friend: Risk Parity, Momentum... (July 2015)
"Our tenure in the investment business has made us keenly aware of a profound investor bias toward complexity. [The] reasons for the bias, which we believe are behavioral in nature. Looking beyond the story telling that characterizes various investment philosophies, the long-term return drivers of many complex smart beta strategies are tilts toward well-known factor/style exposures, such as value, size, and low volatility. Each exposure is a natural outcome of breaking the link between portfolio weighting and price, and of the requisite rebalancing. Complexity creates a problem for investors, which is unfortunately largely self-induced: complexity encourages performance chasing.
Read the paper: The Confounding Bias for Investment Complexity (January 2016)
Blackstone Advisory Partners
"So here are the Surprises of 2016. [Amongst them are the following:], the United States equity market has a down year. Stocks suffer from weak earnings, margin pressure (higher wages and no pricing power) and a price-earnings ratio contraction. Investors keeping large cash balances because of global instability is another reason for the disappointing performance. Growth drops below 5% even though retail and auto sales are good and industrial production is up. The yuan is adjusted to seven against the dollar to stimulate exports. The dollar declines to 1.20 against the euro. China barely avoids a hard landing... The yuan is adjusted to seven against the dollar to stimulate exports."
Read the paper: The Ten Surprises of 2016 (January 2016)
Lazard Asset Management
"Uncertainty is the basis of all financial models and volatility is accepted as the realization of that uncertainty. Several characteristics of financial return series make volatility inherently predictable. However, due to the stochastic nature of volatility, there is no amount of past
data that we can plug into a model that will fully capture the current or future behavior of volatility. Some models are better at predicting equity market volatility while others are better at predicting interest rates or currencies. Each successive level
of complexity added to these volatility predictive models increases the
degree of specificity. [But] complexity can also engender a false sense of over-confidence in the model’s predictions.."
Read the paper: Predicting Volatility (December 2015)
Emory University et al.
"We ask nearly 400 CFOs about the definition and drivers of earnings quality... CFOs believe that the hallmarks of earnings quality are sustainability, absence of one-time items, and backing by actual cash flows. On earnings mis-representation, CFOs believe that in any given period a remarkable 20% of firms intentionally distort earnings... Lack of correlation between earnings and cash flow is the top choice [of red flags], followed by unwarranted deviations from industry or other peer norms... One CFO stressed '...if the accounting policies and principles are not being consistently applied, that's a huge red flag, and there better be a dog-gone reason that something changed.' "
Read the paper: The Misrepresentation of Earnings (June, 2015)
AQR Capital Management
"Are defensive stocks expensive? [Should investors] be concerned about the valuations of defensive stocks when considering an allocation to the style? Preliminary evidence suggests only a tenuous link between valuations and returns for style premia. The predictive relation appears modest. Here we document an even more basic failure: the contemporaneous relation between value spread changes and realized returns is weaker than many investors may expect... We document that despite the recent popularity of the low-beta anomaly, defensive stocks are not particularly expensive (compared to riskier stocks) from a historical perspective."
"This report is the first to solicit the views of
pension plans on how QE is affecting them.
The longer the QE lasts, the more difficult
it is to predict the risk–returns features
of different asset classes, their inter-correlations and their diversification
potential. Key elements of prudent pension
investing are reduced to guesswork. Sudden swings in investor sentiment will continue to translate into far bigger price moves... Lower forward-looking
returns do not imply lower forward-looking volatility. Dynamic investing is now
equated with dynamic risk management. [And] there is a renewed emphasis on
managing asset-specific idiosyncratic risk, as distinct from market risk."
"When investing, I ignore the popular game of trying to predict short-term price changes. Instead, I pay attention to valuation. As a long-term investor, we experience short-term price volatility as opportunity, and high prices as risk. The volatility of equity prices leads to opportunity for investing in equity markets. I am invested in cheaply priced EM equity. We estimate an 8% long-term real return from investing in EM equity at today’s low prices. In contrast, equities in the United States are far more expensive. We estimate long-term real returns of only 1% for investing in the U.S. market at today’s high prices..."
Read more: Investing versus Flipping (October 2015)
Harvard Management Co.
"Like many, I believe that the annual “horse race” between endowment returns is counterproductive to fostering the appropriate long-term investment strategies suitable for Harvard. [We] have aimed to build a process that is capable of expressing less quantifiable investment ideas and objectives around a rigorous core. Increasingly, investment opportunities lie at the border of traditional asset classes, or are informed by knowledge from different areas. I also believe that we should align compensation more closely with the aggregate goals of HMC.. in addition to the success of individual portfolios."
Read more: A Letter from Stephen Blyth(September 2015)
"Widespread adoption of Active Share - generated by changing client demands or regulatory requirements - may render Active Share useless as a predictor of performance going forward, as managers have plenty of tools at their disposal to increase their portfolios' Active Share without becoming more skilled. Active Share depends on benchmark and investment style. Targeting a fixed Active Share threshold might have unintended consequences in times of financial distress. Investors might reasonably wish to decrease both Active Share and Tracking Error in very volatile periods."
"Momentum, one of a handful of equity
factors that empirically displays robust
equity returns, has recently become popular as investors explore factor investing. When used in the sense of investing, momentum refers to movement in stock prices. Several explanations exist for the energy that creates the prolonged movement of stock prices higher or lower. The most convincing explanation in our view is that investors initially underreact to earnings surprises. Buying into positive price momentum generates a capital gain for an investor. The catch is that, as in physics, what goes up must come down..."
"Although Graham did not live to see the explosion of index funds that originated with John Bogle at Vanguard in 1975, indications are that he would have found much about them to likes... Graham consistently stressed the importance of value investing [and] preferring the objective to the subjective [and] admonished investors not to sell securities, especially on the downside, if their fundamentals remain sound. Although beta cannot be smart or stupid, the ways we embrace beta can be either. A “Ben Graham defensive investor” should find much to like in the RAFI™ Fundamental Index™ strategy."
"This paper challenges the notion that active fund management – in aggregate and after fees – is a negative sum game. While the idea of price efficiency is simple and intuitive, it is arguably based on some highly questionable simplifying assumptions about investor rationality, the capacity to interpret information correctly no matter how it is presented and the ability to learn quickly from past
mistakes. [D]espite the practical problems associated with determining skill, seeking out skilful asset managers really can be worth the governance budget.
"There is perhaps no question in money management as controversial as the question of whether active mutual fund managers can outperform monkeys throwing darts. If alpha does not measure managerial skill, then what does? In this article we show that the correct measure of
managerial skill is value added: the total amount of dollars the manager extracts from markets. In this article we document that the average manager is skilled... The evidence of skill that we uncover cannot easily be attributable to luck because cross fund differences in skill are persistent
for as long as 10 years into the future."
Read more: Active Managers Are Skilled (June 2015)
"Public and private pension plans and sovereign-wealth fund managers... do not necessarily have an effective set of implementation strategies/tools to help them realize their aspirations to be long term. Well-substantiated beliefs can help articulate and justify a long-term investment strategy and establish a long
term-focused culture. In the long term, a
focus on avoiding non-recoverable loss delivers the best possible chance of weathering volatility. The appetite for active risk should depend on its quality. Those who can invest long term should
invest long term."
Read more: Long Term Portfolio Guide (March 2015)
"Freeing long-only managers from the constraints of a benchmark and allowing them to be more active in their use of investment techniques will be seen as the best option for preserving traditional asset managers' active franchises. The largest
dislocations in market share we anticipate include i) a 6% shift in active long-only management from benchmarked to unconstrained funds; and ii) a 6% shift in market share passive fund management from benchmark trackers to “more
active” passive funds represented by smart beta or the actively managed ETF space."
Lyxor Asset Management
"Smart beta doesn’t just mean indexing. Some smart beta strategies have been
developed to address risks in traditional, capitalisation-weighted indices... We can think of smart beta as falling into two primary categories. First, there are smart beta strategies which have a specific
investment outcome in mind. A second category of smart beta focuses on risk factors. The main differences between index-based and active smart beta lie in the way the smart beta strategy is implemented. [Smart beta] helps investors pay less for a number of strategies that
were traditionally offered as pure alpha."
Read more: Smart Beta Broader Than You Think (May 2015)
"Clearly not all investors are convinced by Abe’s attempts at reform. An analysis of the last two years paints a very different picture of where Japan is today than where one would surmise by reading the opinion of western commentators or looking at the internal sectors in the market. Japanese companies have become more profitable and are acting in the interest of share-holders with rising dividends, buybacks, and return on equity (ROE). Japanese market valuations are cheap and do not reflect that the country is potentially emerging from its deflationary slump."
"The prominence and availability of performance history influences many investors to rely excessively on such data. Based on the Fundamental Law of Active Management, combining Active Share (AS) and Concentration Coefficient (CC) appears to improve the Law's predictive power. ...achieving high AS by constructing increasingly concentrated portfolio may be counterproductive... Instead, managers may do better by seeking to increase both."
AQR Capital Management
"We evaluate the claim that
the Active Share predicts investment performance by considering theoretical arguments and via empirical analysis. We do not find strong economic motivations for why Active Share may correlate with performance. Active Share is as likely to correlate positively with performance as it is to correlate negatively. We conclude that neither theory nor data justify
the expectation that Active Share might help investors improve their returns."
Read more: Deactivating Active Share (April 2015)
"Timely information flows within the organization lead to better fund performance, and even more so when information flows across funds with different rather than similar investment styles. Simply put, knowing what information has been collected or what analysis has been conducted by other members of the fund family could inform the PM about new stocks that she has not followed before (increased breadth) or add to the depth of her existing knowledge about stocks she is currently following. Mutual fund families could benefit... by removing formal or informal barriers that slow down information transfers within their organizations.
Read more: Deactivating Active Share (April 2015)
"Sustainability topics can have a material effect on a company’s risk profile,
performance potential and reputation and hence have a financial impact
on a firm’s performance. The main results of the report are 90% of the cost of capital studies show that sound ESG standards lower the cost of capital; 88% of the studies show that solid ESG practices result in better operational performance; and 80% of the studies show that stock price performance is positively influenced by good sustainability practices.
It is in the best interest of institutional investors and trustees to require the inclusion of sustainability parameters into
the overall investment process."
"We believe income, gains and alpha should be the building blocks of a portfolio regardless of source. The investment world is dominated by the notion that equities will provide the highest return over the long term and that bonds should be included in a portfolio to offset some of the risk that comes with equities while providing incremental income. We would like to challenge these ideas in the current environment. By starting with income as the primary objective, an investor can more easily estimate long-term returns. [Investors] should seek to reduce their dependence on equity beta and increase their dependence on income for long-term returns."
"Do smart beta prodcuts deliver on their promise of outsmarting traditional cap-weighted indexes...? One of the key reasons why investors are attracted to smart beta ETFs is their potential to deliver positive benchmark-adjusted performance during different market regimes. Results suggest that smart beta ETFs provide a mixed 'bag' of both intended and unintended factor tilts which tend to result in 'performance wash' when it comes to beating their benchmarks. In other words, extra excess return from positive relative exposure to beta and volatility factors tends to get offset by negative exposures to value, momentum and quality which work to cancel out each other."
Read more: How Smart are "Smart Beta" ETFs (April 2015)
"While the recent downturn in both valuations and return on equity might suggest that now is the time to begin buying public emerging market equities en masse, we do not hold that view. A significant portion of the underperformance
of EM public equities in recent years has been linked to multiple contraction in the public markets. Despite GDP growth that is notably faster than in the developed
markets, corporate earnings in the EM world have lagged badly. Our research shows that now is still not the time to make the big EM, cycle-turning equity bet,
particularly given our ongoing concern about EM currencies. Rather, we prefer increasing exposure through selectivity."
"We examine the effectiveness of applying a trend following methodology to global asset allocation between equities, bonds, commodities and real estate. Perhaps the greatest benefit of trend following is the reduction in volatility that accrues to this approach by being out of markets during substantial periods of decline. This in turn leads to huge reductions in the maximum drawdown an investor would experience. Portfolios that combine trend following and momentum show much improved risk-adjusted performance, smaller drawdowns and less negative skew that the latter alone."ther, we prefer increasing exposure through selectivity."
"Less than half of PRI asset owner signatories include specific guidelines on environmental and social issues and, in many cases, investment mandates lack
detail on asset owners’ specific ESG expectations of their managers. [And] many asset owners are yet to be convinced that focussing on ESG issues can add value to investment decision-making. Investment consultants say that asset owners rarely raise responsible investment issues with them, which makes
them less willing to raise responsible investment with their clients, and limited their willingness to integrate responsible
investment into their mainstream service offerings. Asset owners should do significantly more to deliver a sustainable financial system, even in the absence of
Read the paper: How Asset Owners can drive Responsible Investment (March 2016)
"Cyclicality is an inherent feature of
investing (climate), with sometimes
volatile swings in returns (weather)
over each cycle. But none of this, on the
face of it, suggests a strategy is good or
bad. It just means staying the course will
be more or less uncomfortable. Let us look more closely at the “seasonality”
of a U.S. equity value strategy. The last two years or so have been characterised by somewhat extraordinary circumstances in which value has been punished across virtually all sectors on a global scale. [But] value strategies generate substantial excess returns in the long run, at least for those who can commit to the strategy despite ups and downs
Read the paper: Greetings from the Cold (March 2016)
"The key question is whether we are facing a new EM crisis – which could have contagion effects on the global economy – or a more benign outlook for growth. Overall, EM economies are in a significantly stronger financial position than back in 1997... The US consumer remains resilient, and The European Central Bank (ECB) and the Bank of Japan (BOJ) remain vigilant and on target with their quantitative easing programs. A serious economic deceleration in EM appears unlikely, but economic dynamics also do not suggest any significant upside for financial markets. Sector and stock selection will drive alpha rather than broader country-level allocation given the unusually uncertain environment."
The Hamilton Project
"Technology is creating exciting new opportunities to link workers who provide services directly to customers, with
potentially large gains in the quality, speed, and efficiency of service. New and emerging work relationships arising in the “online gig economy” do not fit easily into the existing legal definitions of
“employee” and “independent contractor” status. This paper proposes a new legal category, which we call “independent workers,” for those who occupy the gray area between employees and independent contractors. Intermediaries could use their scale and pooling opportunities to offer independent workers a range of insurance services, tax preparation assistance, and financial services."
Read the paper: The "Independent Worker" (December 2015)
Financial Analysts Journal
"Smart beta products are a disruptive financial innovation with the potential to significantly affect the investment management industry... The reason for this potential is that many traditional active managers deliver a significant fraction of their active returns via static exposures to smart beta factors while charging active fees. Smart beta products use simple, rule-based, transparent approaches to building portfolios that deliver fairly static exposures (relative to capitalization-weighted benchmarks) to characteristics historically associated with excess risk-adjusted returns. The managers who offer a mix of smart beta and pure alpha at fees too high for the mix face... extinction."
Toulouse School of Economics
"Are short-term bonuses harmful for market informational efficiency? Does short-term compensation prevent fund managers from taking into account the long-term value of assets? Short-termism is financial markets is hard to reconcile with finance theory because of market efficiency. A widespread view in the financial industry is that relying on short-term performance makes it harder to implement a long-term strategy. This paper sheds light on the link between short-termism and short-term based compensation in the asset management industry and assesses whether a longer-term performance horizon can be helpful. The optimal compensation contract can be..."
Environmental Agency P/Fd
"In 2014/15 the Environment Agency Pension Fund launched a search for new managers for its global sustainable equity mandate, after significant team changes with the existing manager. In the search, we paid particular attention to the link between ESG analysis and financial return: managers who are able to use sustainability to add value. It has never been easier to take a responsible investment approach in an equity mandate.
For the EAPF, however, we look for something extra: for example, – a strategic understanding of sustainability or an enhanced ability to extract value from ESG factors. Clearly there is more competition, but the market is hopefully growing fast."
Read the paper: Sustainable Global Equity Managers (July 2015)
Pictet Asset Management
"As the world’s political leaders move towards providing clean water and modern sanitation for all, a heavily regulated,
state-controlled industry is set to liberalise, opening doors to investors. Achieving universal coverage in safe drinking
water and sanitation will require investing the equivalent of 0.1 per cent of global gross domestic product, or around
USD53 billion over five years, according to the UN. The fact that the UN recognises a pivotal role for the private
sector working alongside governments and international organisation in achieving these goals gives cause for optimism, Pictet advisory board members said."
Read the paper: Water: Looking for
"Aging populations, longer life expectancy and falling birth rates will dampen Europe’s potential economic growth rate in the coming decades. There are two primary options for the citizens of Europe to maintain their relatively high degree of prosperity. One is immigration. The other is to significantly enhance productivity through reform. To compete with larger nations and unleash its full economic potential, Europe needs to transform itself into something more than a single trading bloc. The immediate challenge is for European nations to pull together in multiple areas. The uncertainty hanging over Europe raises questions about where the continent is headed and what forces are shaping it. ."
Read the paper: The Future of Europe (January 2016)
University of Chicago
"People often interpret information by contrasting it with what was recently observed [and] perceive signals as higher or lower than their true values depending on wha was recently observed. Contrast effects in financial markets would imply that prices react not only to th absolute content of news, but also to a bias induced by the relative content of news. In this paper, we tst whether contract effects distort market perceptions to firm earnings announcements. We find that the reaction to an earnings announcement is inversely related to the level of earnings surprise announced by large firms in the previous day. [Firms] may strategically time the release of...news in order to take advantage of contrast effects..."
Read the paper: A Tough Act to Follow (June 2015)
"[Despite] its clear importance, very little is known about knowledge management in asset management. This article thus seeks to remedy this by offering insight into the role that knowledge plays in the investment process and, more specifically, into the adoption of knowledge manage-ment by asset managers. Most asset managers could not be described as
knowledge managers at all. Knowledge
is about converting information into action[Most] organizations don’t know what they do know let alone what they don’t know, which means they require structured ways of learning and sharing. And, as we found in our research, this is particularly true in asset management..."
University of New Brunswick
"Modern Portfolio Theory, standard asset pricing models and the concept of rational decision maker in efficient markets have major limitations as systes for modelling investor behaviour and prices of financial assets. We are at the stage where we need more realistic models. Value investing has never been a darling model of academics...[but it's] a system of investment decision making that has withstood the test of time and economic, business and financial cycles for over 80 years. It may contain the seed for a formal theory of a behavioural-based portfolio theory. For value investors, financial markets are not always efficient."
T Rowe Price
"Volatility returned to markets with a vengeance during the summer amid growing concerns about China, sharp declines in commodity prices, and uncertainty over whether the U.S. Federal Reserve would raise rates in September. When volatility is high and the global
macroeconomic picture is mixed, bond
investors need to review their existing
fixed income allocation... To profit from volatility... [f]lexibility is also required to invest across markets and different types of bonds, on both the long and short side. By adopting a genuinely unconstrained
bond strategy, an investor can seek value
anywhere in the world..."
University of Wyoming
"Using data on security holdings of 10,771 institutional investors from 72 different countries, we test whether concentrated investment strategies result in superior abnormal returns to institutional investors. Traditional portfolio theory predicts that investors’ portfolios should be diversified. [Another] another strand of theoretical literature argues that portfolios can be underdiversified but optimal if they are based on information advantage. We find strong support for the information
advantage theory with respect to all concentration measures. Results show that ...focus lead to higher abnormal returns of institutional investors..."
HEC Paris | University of Cologne
"We study the dynamics of fund manager ownership for a sample of U.S. equity mutual funds from 2005 to 2011. We find that ownership changes positively predict changes in future risk-adjusted fund performance. Funds that are required to increase their ownership are associated with an increase in alpha by up to 1.6 percent per standard deviation of ownership increase. They do so by increasing their active share, turnover, unobserved actions, equity holdings and by decreasing their cash holdings."
"The quality factor has demonstrated long-term outperformance against the market, but has not received the same attention as the value, size or momentum factors. Our research shows that quality has low or negative active return correlations with other systematic factors, especially value and low size. In addition, the MSCI World Quality Index has exhibited a similar defensive characteristic as the MSCI World Minimum Volatility Index in high volatility regimes, though they had different exposures to the size and leverage factors. Understanding how quality performs in different parts of the market cycle is critical..."
Oaktree Capital Management
"[Charlie Munger] said something about investing that I keep going back to: 'It's not supposed to be easy. Anyone who finds it easy is stupid.' In my view...anyone who thinks it's easy to achieve unusual profits is overlooking the way markets operate. What's clear to the broad consensus of investors is almost always wrong. [The] best buys are usually found in the things most people don't understand or believe in. The trust is, the herd is wrong about risk at least as often as it is about return. I'm firmly convinced that investment risk resides most where it is least perceived, and vice versa."
Read more: It's not easy (September 2015)
"Through air, across water and on land; we have long been fascinated with the speed and efficiency of getting from A to B.
Yet for an industry constantly moving, on a day-to-day basis we give it little thought. Today, ...the new breed of ultra large container vessels responsible for carrying the majority of the world’s goods. [In the air] making jet engines work harder,
aeroplanes lighter, seats thinner and
component parts less complicated all
serves to make our flights less
expensive and more environmentally
friendly. Recent developments could
even affect property prices."
Bluebay Asset Management
"An aggregate approach to emerging market (EM) hard currency debt provides investors access to a broader and more diverse credit universe in an efficient way... [It] is worth noting that the current spread levels, relative to historical trends, appear
to offer sufficient room for spread compression going forward – both on a standalone basis and when compared to respective developed market counterparts. As EMD sectors mature and investors look closely for differentiation, there are increasing divergences of returns between the sectors. Given this divergence, it is important to actively asset allocate to obtain the most efficient mix..."
Read more: Emerging Market Aggregate (July 2015)
"The world of data is exploding. The world may be entering a period of even more rapid productivity gains thanks to the remarkable power of data. [B]ig Data is not primarily about computers. The real benefit is what humans do with the insights Big Data can generate. We believe insight, not data, is what drives value. [Investors] should recognize [the Data Revolution's] potential to reshape the economic landscape. Today, data has broadened the opportunity for information advantage substantially. The analysis of unstructured data is where considerable energy is focused today."
"Among institutional investors with long-term portfolios, the practice of delegating a significant portion of the investment
office function to a third-party provider, typically an investment management or consulting firm, has increased steadily
over the past decade. Outsourcing, as it is broadly known (the terms “outsourced chief investment officer” or “OCIO” are
also used), encompasses a wide range of models... A key determinant of the success of an organization’s OCIO
model is defining the respective roles and responsibilities of the institution’s board, staff, investment committee and the outsourced CIO."
Pyramis Global Advisors
"The perception of Japanese corporate management quality and corporate governance has often been unfavorable when compared to global peers. The reforms Japan is enacting, in addition to
measures already adopted on the corporate level, should benefit shareholders in multiple ways. We expect to see
increased independent oversight, better management accountability, more efficiently utilized balance sheets, and
higher levels of profitability. This in turn suggests investors should be willing to pay sustainably higher multiples for Japanese shares."
"...there is much evidence that in the portfolio construction context, carry and trend are mutually diversifying, especially in extreme states. Thus, it is intuitively appealing to combine them. Conceptually, we can think of carry as a position that harvests risk premiums, and thus, performs best when prices don't move much, where as trend-following is a long-tail option-replicating strategy, which benefits when prices move as a consequence of fat-tail events...the best strategy for long term portfolio construction is: 'Be on the right side of the trend, and don't pay too much while you are at it.'"
"Despite cyclical price and yield fluctuations, high-yield bonds, especially those of mid- to-high-credit quality, have demonstrated their ability to diversify portfolios... With the multiyear tailwind of declining interest rates beginning to reverse, investors should no longer expect price gains to contribute as much to returns going forward. Our conclusion is that, despite short-term price volatility, year-over-year price fluctuations tend to cancel each other out on a cumulative basis over the longer term, allowing the income component (i.e. the coupon) to drive total returns."
MSCI Equity Research
"Systematic factor premia exist in emerging markets. Momentum exhibited the greatest performance... while Dividend Yield factor returns jumped significantly after the financial crisis. In emerging markets, both dividend per share and earnings per share growth have exceeded those exhibited by the MSCI World and USA indexes during the January 2003 to August 2014 period... Combining factors in emerging markets provides investors with valuable diversification effects..."
"Liquidity is ephemeral: it can come and go. The liquidity of an asset often depends on which way you want to go... and which way everyone else wants to go. Usually, just as a holder's desire to sell an asset increases, his ability to see it decreases. A high degree of concern over liquidity can push investors to avoid it to excess. Let's remember that liquidity isn't free. There's usually a cost, and it comes in the form of return forgone. I believe... investors [are] failing to understand [liquidity's] transitory nature.
Read more: Liquidity & Opportunities (March 2015)
"When it comes to bad ideas, finance certainly offers up an embarrassment of riches. [Jack] Welch said "Shareholder value is the dumbest idea in the world." Given the shortening lifespan of a corporate and the decreasing tenure of CEOs, the finding that many managers are willing to sacrifice long-term value for short-term gain probably shouldn't be a surprise. Only by focusing on being a good business are you likely to end up delivering decent returns to shareholders. Shareholder value maximization may actually have led to poorer corporate performance!"
Read more: The World's Dumbest Idea (Dec 2014)
"The key to understanding current consumption patterns is to analyse historical spending behaviour and the evolution of its major drivers over time. What the financial crisis did was lay bare the ugliness of a growing income gap by removing the layer of debt accumulation that had been masking its presence. How consumers feel about their future finances tends to dictate how they spend today. Since the financial crisis, spending patters for higher and lower income groups have diverged. Stronger growth in wages and salaries is essential to the macro outlook, because it would help household spend more broadly across the income spectrum."
Read more: Inequality and Consumption (September 2014)
"Empirical evidence shows that active management results tend to be cyclical and past out-of-favour periods have been followed by strong performance reversals. Performance by active managers not only appears to be cyclical, but often tends to be influenced by the direction and magnitude of market performance. By not realizing all the downside, skilled active managers tend to outperform over the long term regardless of the cyclical headwinds in sharply rising markets. A skilled manager can potentially add value over time, particularly during down markets. Passive management is only as safe as the asset class it aims to replicate.
"How should active management be measured? Active Share is a reasonable proxy for stock selection, whereas tracking error is a proxy for systematic factor risk. An Active Share of 50% is the theoretical minimum that a pure active manager could have. The only group that added value for investors was active stock pickers. In contract, factor bets, as indicated by high tracking error, are not rewarded in the market. Concentrated funds exhibit economically significant performance persistence, even after controlling for stock-level momentum. Fund manager performance and skill are closely related. When selecting funds [...] pick from the two extremes of Active Share."
Aon Hewitt Investment Consulting
"How can we reconcile the academic research suggesting that markets are predictable with conventional
wisdom that people cannot predict where the markets are going? Rather than holding a constant strategic asset allocation, long-term investors would have been better off increasing their allocation to
equities when valuations were cheap, and decreasing their exposures when valuations were expensive. The practical implication for investors is that they can improve their strategies by adjusting their asset allocations over time, rotating emphasis when and where expected risk premiums are more favorable,
and scaling back exposures that are less desirable."
Read more: Asset Allocation through
TIAA-CREF Asset Management
"Despite cyclical price and yield fluctuations, high-yield bonds – especially those of mid- to-high-credit quality – have demonstrated their ability to diversify... Given our view of a stable environment for corporate fundamentals, we believe the primary risk to high-yield returns this year is the potential headwind of rising interest rates. Compared to fixed-income alternatives, high-yield bonds have been less sensitive to interest-rate fluctuations, as reflected in their negative correlation with Treasuries. More importantly, in prior periods of relatively moderate and steady rate increases such as we may now be facing, high-yield bonds actually outperformed."
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