Pub Date : 2018-08-31DOI: 10.3905/jii.2018.9.2.001
Brian R. Bruce
{"title":"Editor’s Letter","authors":"Brian R. Bruce","doi":"10.3905/jii.2018.9.2.001","DOIUrl":"https://doi.org/10.3905/jii.2018.9.2.001","url":null,"abstract":"","PeriodicalId":36431,"journal":{"name":"Journal of Index Investing","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2018-08-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"https://sci-hub-pdf.com/10.3905/jii.2018.9.2.001","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"44229586","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2018-08-31DOI: 10.3905/jii.2018.9.2.027
W. Pennington
We eliminate the primary source of uncompensated risk from trading in one of the largest sectors of the global financial markets. Market infrastructure enhancements are achieved in the foreign exchange (FX) forward contract market by integrating distributed ledger technology (DLT) into the creation of collateral-linked contracts for currency forwards (CLCF). Specifically, we deploy DLT with embedded automation as the shared platform for bilateral FX forward contracts, including operational provisions of International Swaps and Derivatives Association and Credit Support Annex agreements. Through automation, we link the economics of the currency forward contract and the price-volatility-induced counterparty exposures, bringing intraday counterparty risk to within mutually acceptable ranges. The essential benefits of the over-the-counter market structure are preserved because CLCF contracts remain bilateral to allow for customized terms and conditions between market participants. Reduced concentration risk is also preserved because there is no central counterparty or central clearing organization into which all risks are pooled. As a result, liquidity is enhanced and risk is reduced in the FX forward contract market.
{"title":"The Collateral-Linked Currency Forward (CLCF) Contract: Blockchain-Enabled OTC Currency Forward Market Infrastructure","authors":"W. Pennington","doi":"10.3905/jii.2018.9.2.027","DOIUrl":"https://doi.org/10.3905/jii.2018.9.2.027","url":null,"abstract":"We eliminate the primary source of uncompensated risk from trading in one of the largest sectors of the global financial markets. Market infrastructure enhancements are achieved in the foreign exchange (FX) forward contract market by integrating distributed ledger technology (DLT) into the creation of collateral-linked contracts for currency forwards (CLCF). Specifically, we deploy DLT with embedded automation as the shared platform for bilateral FX forward contracts, including operational provisions of International Swaps and Derivatives Association and Credit Support Annex agreements. Through automation, we link the economics of the currency forward contract and the price-volatility-induced counterparty exposures, bringing intraday counterparty risk to within mutually acceptable ranges. The essential benefits of the over-the-counter market structure are preserved because CLCF contracts remain bilateral to allow for customized terms and conditions between market participants. Reduced concentration risk is also preserved because there is no central counterparty or central clearing organization into which all risks are pooled. As a result, liquidity is enhanced and risk is reduced in the FX forward contract market.","PeriodicalId":36431,"journal":{"name":"Journal of Index Investing","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2018-08-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"https://sci-hub-pdf.com/10.3905/jii.2018.9.2.027","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"43733160","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2018-08-31DOI: 10.3905/jii.2018.9.2.066
Ananth Madhavan, A. Sobczyk, Andrew Ang
The authors examine the factor exposures of several popular market-capitalization indexes and how they vary over time. The authors find that most market-capitalization-weight indexes are effectively exposed to only two or three factors, with value and momentum being increasingly dominant. They find that the proportion of index movements explained by factors has materially increased in recent years, which is consistent with a more top-down, macro-driven environment or the increasing importance of economy-wide risks for financial markets.
{"title":"What’s in Your Benchmark? A Factor Analysis of Major Market Indexes","authors":"Ananth Madhavan, A. Sobczyk, Andrew Ang","doi":"10.3905/jii.2018.9.2.066","DOIUrl":"https://doi.org/10.3905/jii.2018.9.2.066","url":null,"abstract":"The authors examine the factor exposures of several popular market-capitalization indexes and how they vary over time. The authors find that most market-capitalization-weight indexes are effectively exposed to only two or three factors, with value and momentum being increasingly dominant. They find that the proportion of index movements explained by factors has materially increased in recent years, which is consistent with a more top-down, macro-driven environment or the increasing importance of economy-wide risks for financial markets.","PeriodicalId":36431,"journal":{"name":"Journal of Index Investing","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2018-08-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"https://sci-hub-pdf.com/10.3905/jii.2018.9.2.066","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"41793032","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2018-08-31DOI: 10.3905/jii.2018.9.2.018
J. Hsu, Xiaoyan Liu, Keren Shen, V. Viswanathan, Yanxiang Zhao
To maximize their effectiveness, environmental, social, and governance (ESG) strategies should target those ESG firms that are most capital constrained. Inherently, this involves seeking ESG firms that have irrationally high costs of capital and thus high expected return. We replicate results that find returns among ESG firms that are similar to those among non-ESG firms. In addition, we find that sorting stocks based on cost of equity capital generates significant positive return for both ESG and non-ESG firms. Investing in an ESG in Need index, which contains only high-ESG companies and tilts toward firms with high cost of capital, thus generates both higher social value and better return than investing in traditional capitalization-weighted ESG indexes.
为了最大限度地提高其有效性，环境、社会和治理（ESG）战略应针对资本最受约束的ESG公司。从本质上讲，这涉及到寻找具有非理性高资本成本和高预期回报的ESG公司。我们复制了ESG公司与非ESG公司的回报率相似的结果。此外，我们发现，基于股本成本对股票进行排序，对ESG和非ESG公司都产生了显著的正回报。投资ESG in Need指数，该指数只包含高ESG公司，并倾向于资本成本高的公司，因此比投资传统的资本加权ESG指数产生了更高的社会价值和更好的回报。
{"title":"Outperformance through Investing in ESG in Need","authors":"J. Hsu, Xiaoyan Liu, Keren Shen, V. Viswanathan, Yanxiang Zhao","doi":"10.3905/jii.2018.9.2.018","DOIUrl":"https://doi.org/10.3905/jii.2018.9.2.018","url":null,"abstract":"To maximize their effectiveness, environmental, social, and governance (ESG) strategies should target those ESG firms that are most capital constrained. Inherently, this involves seeking ESG firms that have irrationally high costs of capital and thus high expected return. We replicate results that find returns among ESG firms that are similar to those among non-ESG firms. In addition, we find that sorting stocks based on cost of equity capital generates significant positive return for both ESG and non-ESG firms. Investing in an ESG in Need index, which contains only high-ESG companies and tilts toward firms with high cost of capital, thus generates both higher social value and better return than investing in traditional capitalization-weighted ESG indexes.","PeriodicalId":36431,"journal":{"name":"Journal of Index Investing","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2018-08-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"https://sci-hub-pdf.com/10.3905/jii.2018.9.2.018","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"45740280","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2018-08-31DOI: 10.3905/jii.2018.9.2.034
M. Alighanbari, S. Doole
Capacity measures how much can be invested in a strategy before declining expected returns make competing strategies look more attractive. Existing approaches for measuring capacity are often based on a strategy’s expected return and hence are vulnerable to estimation error. Using the exposure characteristics of factor indexes is an alternative way of gauging the capacity pressure such strategies may be facing. This article discusses different ways of controlling investment capacity in designing a factor index. With careful design, the capacity of a factor index can be improved without significantly compromising exposure to the target factor. Six practical ways are investigated that allow investors to modify their strategies to be capacity-sensitive while still capturing the desired factor exposure: controlling the maximum benchmark multiple, trade size, and turnover and rebalance frequency, alongside the use of staggered and spread rebalancing.
{"title":"The Capacity of Factor Index Strategies: Assessment and Control","authors":"M. Alighanbari, S. Doole","doi":"10.3905/jii.2018.9.2.034","DOIUrl":"https://doi.org/10.3905/jii.2018.9.2.034","url":null,"abstract":"Capacity measures how much can be invested in a strategy before declining expected returns make competing strategies look more attractive. Existing approaches for measuring capacity are often based on a strategy’s expected return and hence are vulnerable to estimation error. Using the exposure characteristics of factor indexes is an alternative way of gauging the capacity pressure such strategies may be facing. This article discusses different ways of controlling investment capacity in designing a factor index. With careful design, the capacity of a factor index can be improved without significantly compromising exposure to the target factor. Six practical ways are investigated that allow investors to modify their strategies to be capacity-sensitive while still capturing the desired factor exposure: controlling the maximum benchmark multiple, trade size, and turnover and rebalance frequency, alongside the use of staggered and spread rebalancing.","PeriodicalId":36431,"journal":{"name":"Journal of Index Investing","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2018-08-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"https://sci-hub-pdf.com/10.3905/jii.2018.9.2.034","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"42459344","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Some of the market-relative performance of U.S. stock mutual funds can be explained by the pure returns to now commonly accepted equity market factors. Historically, managers in the aggregate have had more equally weighted positions than the capitalization-weighted portfolio to which they are typically compared. Currently, the active returns of mutual funds are positively associated with the performance of the momentum and profitability factors and are negatively associated with the performance of the value and low beta factors. These effects are particularly strong in mutual funds with a stated growth objective. Thus, capitalization-weighted indexes outperform active managers most of the time, but especially when the value and low beta factors have high returns and the momentum and profitability factors have low returns.
{"title":"When Does Capitalization Weighting Outperform? Factor-Based Explanations","authors":"R. Clarke, Harindra de Silva, Steven Thorley","doi":"10.3905/jii.2018.1.062","DOIUrl":"https://doi.org/10.3905/jii.2018.1.062","url":null,"abstract":"Some of the market-relative performance of U.S. stock mutual funds can be explained by the pure returns to now commonly accepted equity market factors. Historically, managers in the aggregate have had more equally weighted positions than the capitalization-weighted portfolio to which they are typically compared. Currently, the active returns of mutual funds are positively associated with the performance of the momentum and profitability factors and are negatively associated with the performance of the value and low beta factors. These effects are particularly strong in mutual funds with a stated growth objective. Thus, capitalization-weighted indexes outperform active managers most of the time, but especially when the value and low beta factors have high returns and the momentum and profitability factors have low returns.","PeriodicalId":36431,"journal":{"name":"Journal of Index Investing","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2018-08-07","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"https://sci-hub-pdf.com/10.3905/jii.2018.1.062","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"43952043","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Integration of carbon risks into the investment process requires careful analysis of risk–return characteristics and factor exposures of resulting carbon-efficient portfolios. In this article, we propose a stylized framework to integrate traditional style factors with carbon-efficient portfolios for both U.S and developed Europe markets. The results show that although carbon-efficient factor portfolios do achieve the objective of lowering carbon intensity, they generally have lower risk-adjusted returns than the pure factor portfolios. In addition, carbon-efficient factor portfolios have lower exposure to the targeted factors, and the reductions in factor exposure are statistically significant.
{"title":"Carbon Risk Integration with Factors","authors":"Bill Hao, A. Soe, Kelly Tang","doi":"10.3905/jii.2018.1.061","DOIUrl":"https://doi.org/10.3905/jii.2018.1.061","url":null,"abstract":"Integration of carbon risks into the investment process requires careful analysis of risk–return characteristics and factor exposures of resulting carbon-efficient portfolios. In this article, we propose a stylized framework to integrate traditional style factors with carbon-efficient portfolios for both U.S and developed Europe markets. The results show that although carbon-efficient factor portfolios do achieve the objective of lowering carbon intensity, they generally have lower risk-adjusted returns than the pure factor portfolios. In addition, carbon-efficient factor portfolios have lower exposure to the targeted factors, and the reductions in factor exposure are statistically significant.","PeriodicalId":36431,"journal":{"name":"Journal of Index Investing","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2018-08-07","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"https://sci-hub-pdf.com/10.3905/jii.2018.1.061","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"42193386","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2018-05-31DOI: 10.3905/jii.2018.9.1.006
N. Amenc, Felix Goltz, Sivagaminathan Sivasubramanian
In this article, the authors contrast the claims of promoters of “bottom-up” approaches for constructing multi-factor equity portfolios with relevant findings in the academic literature. In particular, the authors review findings in the academic literature that raise questions on the reliability of the link between factor scores and returns, on possibilities of overstating the backtest performance of bottom-up portfolios, and on the cost of concentration resulting from the chase of factor champions. The article shows that, while bottom-up approaches are driven by a naïve belief into a fine-grain deterministic link between stock-level multi-factor exposures and returns, the empirical evidence in the asset pricing literature only supports the existence of a broad-stroke relationship. Moreover, it is emphasized that bottom-up approaches are prone to over-fitting and multiple testing biases. Without any adjustments for such biases, the backtest results of bottom-up approaches may be overstated. Finally, in the process of chasing factor champions, bottom-up portfolios tend to become highly concentrated while the academic literature stresses that diversification is crucial for the successful harvesting of factor premia. The authors conclude that findings in the academic literature on these three questions give rise to a healthy dose of skepticism concerning the superiority claims of bottom-up proponents.
{"title":"Multifactor Index Construction: A Skeptical Appraisal of Bottom-Up Approaches","authors":"N. Amenc, Felix Goltz, Sivagaminathan Sivasubramanian","doi":"10.3905/jii.2018.9.1.006","DOIUrl":"https://doi.org/10.3905/jii.2018.9.1.006","url":null,"abstract":"In this article, the authors contrast the claims of promoters of “bottom-up” approaches for constructing multi-factor equity portfolios with relevant findings in the academic literature. In particular, the authors review findings in the academic literature that raise questions on the reliability of the link between factor scores and returns, on possibilities of overstating the backtest performance of bottom-up portfolios, and on the cost of concentration resulting from the chase of factor champions. The article shows that, while bottom-up approaches are driven by a naïve belief into a fine-grain deterministic link between stock-level multi-factor exposures and returns, the empirical evidence in the asset pricing literature only supports the existence of a broad-stroke relationship. Moreover, it is emphasized that bottom-up approaches are prone to over-fitting and multiple testing biases. Without any adjustments for such biases, the backtest results of bottom-up approaches may be overstated. Finally, in the process of chasing factor champions, bottom-up portfolios tend to become highly concentrated while the academic literature stresses that diversification is crucial for the successful harvesting of factor premia. The authors conclude that findings in the academic literature on these three questions give rise to a healthy dose of skepticism concerning the superiority claims of bottom-up proponents.","PeriodicalId":36431,"journal":{"name":"Journal of Index Investing","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2018-05-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"https://sci-hub-pdf.com/10.3905/jii.2018.9.1.006","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"48672742","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2018-05-31DOI: 10.3905/JII.2018.9.1.019
Linda H. Zhang
Leveraged and inverse ETFs represent one of fast growing areas in the ETF industry, with the global AUM breaking $60 billion. The regulatory bodies in many countries are approving the listing of these products. The recent financial market turmoil in February 2018 has exposed the risk behavior of these ETFs in the time of market stress, which are often misunderstood by investors and can catch them by surprise. In this study, we analyze leveraged ETFs risk profiles in both short-term and long-term periods. As leveraged ETFs and inverse ETFs are often used for short-term trading purposes, understanding the nature of short-term volatility is highly critical. We also survey the landscape of the major markets with listed leveraged ETFs outside the U.S., including Asia Pacific and Canada. We examined the volatility behavior of leveraged products in these markets and came to the same conclusion. The near-term volatility jumps more than what the leverage ratio suggested. We’ve also noticed the degree of jumps vary from market to market. Globally, leveraged and inverse ETFs are growing at a healthy pace, led by a faster growth in Asia in 2016. After Japan, South Korea, and Taiwan, Hong Kong became the latest market, allowing both inverse and leveraged products on Hong Kong and China stock indexes. It is in the great interest of global investors to fully understand the nature of these instruments to use them effectively in portfolio management.
{"title":"Leveraged ETFs: Are You Prepared for the Volatility Jumps? Global Perspectives on the Short-Term versus Longer-Term Risk Profiles","authors":"Linda H. Zhang","doi":"10.3905/JII.2018.9.1.019","DOIUrl":"https://doi.org/10.3905/JII.2018.9.1.019","url":null,"abstract":"Leveraged and inverse ETFs represent one of fast growing areas in the ETF industry, with the global AUM breaking $60 billion. The regulatory bodies in many countries are approving the listing of these products. The recent financial market turmoil in February 2018 has exposed the risk behavior of these ETFs in the time of market stress, which are often misunderstood by investors and can catch them by surprise. In this study, we analyze leveraged ETFs risk profiles in both short-term and long-term periods. As leveraged ETFs and inverse ETFs are often used for short-term trading purposes, understanding the nature of short-term volatility is highly critical. We also survey the landscape of the major markets with listed leveraged ETFs outside the U.S., including Asia Pacific and Canada. We examined the volatility behavior of leveraged products in these markets and came to the same conclusion. The near-term volatility jumps more than what the leverage ratio suggested. We’ve also noticed the degree of jumps vary from market to market. Globally, leveraged and inverse ETFs are growing at a healthy pace, led by a faster growth in Asia in 2016. After Japan, South Korea, and Taiwan, Hong Kong became the latest market, allowing both inverse and leveraged products on Hong Kong and China stock indexes. It is in the great interest of global investors to fully understand the nature of these instruments to use them effectively in portfolio management.","PeriodicalId":36431,"journal":{"name":"Journal of Index Investing","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2018-05-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"https://sci-hub-pdf.com/10.3905/JII.2018.9.1.019","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"43947754","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2018-05-31DOI: 10.3905/jii.2018.9.1.036
Gerald Abdesaken
Mutual fund managers who adjust portfolio holdings based on analyst coverage and consensus recommendations achieve signi?cantly lower risk-adjusted returns, but perform better than when consensus recommendations are considered alone. In a rational expectations equilibrium setup, an unskilled investor places greater weight on a risky asset’s public signal, given an increase in the asset’s analyst coverage. A new measure of managerial skill based on analyst coverage is formulated and shown to be decreasing in mutual fund alphas.
{"title":"Following the Followers: Mutual Fund Performance When Managers Follow Analyst Coverage","authors":"Gerald Abdesaken","doi":"10.3905/jii.2018.9.1.036","DOIUrl":"https://doi.org/10.3905/jii.2018.9.1.036","url":null,"abstract":"Mutual fund managers who adjust portfolio holdings based on analyst coverage and consensus recommendations achieve signi?cantly lower risk-adjusted returns, but perform better than when consensus recommendations are considered alone. In a rational expectations equilibrium setup, an unskilled investor places greater weight on a risky asset’s public signal, given an increase in the asset’s analyst coverage. A new measure of managerial skill based on analyst coverage is formulated and shown to be decreasing in mutual fund alphas.","PeriodicalId":36431,"journal":{"name":"Journal of Index Investing","volume":null,"pages":null},"PeriodicalIF":0.0,"publicationDate":"2018-05-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"https://sci-hub-pdf.com/10.3905/jii.2018.9.1.036","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"42807699","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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