Investing Expertise

What are asset class return expectations and associated portfolio allocations of very sophisticated U.S. investors? In their February 2019 paper entitled “The Return Expectations of Institutional Investors”, Aleksandar Andonov and Joshua Rauh analyze disclosures of expected returns across asset classes among U.S. public pension funds, which hold assets of about $4 trillion (see the first chart below), including fixed income, cash, equities, real assets, hedge funds, private equity and other asset classes. Taking into account past fund performance, they investigate how fund managers estimate future returns. Disclosures also reveal target allocations to asset classes (see the second chart below). Together, expected asset class returns and target allocations allow calculation of expected portfolio returns. Using annual disclosures for 228 U.S. state and local government pension plans during 2014 through 2017, they find that:

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Are there relationships between (1) the stock market outlook expressed by a U.S. equity mutual fund manager in semi-annual reports and (2) positioning and performance of that fund? In his October 2019 preliminary paper entitled “Are Professional Investors Prone to Behavioral Biases? Evidence from Mutual Fund Managers”, Mehran Azimi examines these relationships. Specifically, for each such U.S. equity mutual fund semi-annual report, he:

1. Uses a word list to identify parts of fund reports that may contain stock market outlooks.
2. Applies machine learning to isolate sentences most likely to present outlooks.
3. Manually reads and rates these sentences as bearish, neutral or bullish.
4. Computes fund manager “Belief” as number of bullish sentences minus number of bearish sentences divided by the total number of sentences isolated. Positive (negative) Belief indicates a net bullish (bearish) outlook.

He then employs regressions to relate fund manager Belief to fund last-year return, asset allocation, portfolio risk and next-year 4-factor (adjusting for market, size, book-to-market and momentum) alpha. Using 40,731 semi-annual reports for U.S. equity mutual funds and associated fund characteristics, holdings and returns during February 2006 through December 2018, he finds that:

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What are ways to mitigate biases that interfere with rational investment decision-making? In their September 2019 paper entitled “The Psychology of Financial Professionals and Their Clients”, Kent Baker, Greg Filbeck and Victor Ricciardi describe common psychological biases and suggest ways to overcome them. Based on their knowledge and experience, they conclude that: Keep Reading

When media recommend stocks, should investors pay attention? To check, we look at performance of stock recommendations for 2019 from December 2018 articles in several publications. Specifically, we test:

• 10 buy recommendations from InvestorPlace published 12/13/2018.
• 19 buy recommendations from Kiplinger published 12/7/2018.
• 8 buy recommendations from Motley Fool published 12/13/2018, 12/21/2018 and 12/22/2018.
• 10 buy recommendations from TheStreet published 12/3/2018 and 12/14/2018.
• 19 buy recommendations from USA Today published 12/28/2018.
• 8 buy recommendations from US News published 12/14/2018.

For each source, we form equally weighted portfolios of recommended stocks at the close on 12/31/2018 and hold without rebalancing. For a broader perspective, we form an equally weighted portfolio of all recommended stocks (Overall). Because the sample period is very short, we focus on daily performance statistics, but also look at cumulative returns. We use SPDR S&P 500 (SPY) as a benchmark. Using daily dividend-adjusted prices of the 74 recommended stocks and SPY during 12/31/2018 through October 15, 2019, we find that: Keep Reading

Is there a way that asset managers can share knowledge/data across proprietary boundaries with many researchers to advance development of investment strategies? In their September 2019 paper entitled “Crowdsourced Investment Research through Tournaments”, Marcos Lopez de Prado and Frank Fabozzi describe highly structured tournaments as a crowdsourcing paradigm for investment research. In each such tournament, the organizer poses one investment challenge as a forecasting problem and provides abstracted and obfuscated data. Contestants pay an entry fee, develop models and provide forecasts, retaining model ownership by running calculations on their own hardware/software. Based on this hypothetical tournament setup and their experience, they conclude that:

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What should investors expect to see in a typical investment advisor’s model portfolio? In their July 2019 paper entitled “Factors and Advisors Portfolios”, Brian Lawler, Andrew Ang, Brett Mossman and Patrick Nolan examine patterns and factor exposures in detailed holdings for a large number of model portfolios from many types of investment advisors. When holdings are funds, they examine contents of the funds. They assess exposures to economic growth, real interest rates and inflation. Within equity holdings, they assess exposures to size, value, momentum, quality and volatility factors. Using holdings of 9,940 model portfolios provided by investment advisors during October 2017 through September 2018, they find that: Keep Reading

Would retail investors improve portfolio performance by using robo-advisors to manage holdings they have selected? In their July 2019 paper entitled “Artificial Intelligence Alter Egos:Who benefits from Robo-investing?”, Catherine D’Hondt, Rudy De Winne, Eric Ghysels and Steve Raymond compare performances of portfolios held by each of a large sample of actual individual investors to that of a robo-investor constrained to the stocks and exchange-traded funds (ETF) held by that investor over a rolling 2-year historical window. They consider three robo-investor strategies:

1. Mean-variance optimization with guiding average and variance estimates based straightforwardly on 2-year rolling historical windows and parameters set to maximize Sharpe ratio.
2. Mean-variance optimization guided by machine learning algorithms and sophisticated covariance estimators, with two variations in variance estimation.
3. Equal weight.

Robo-investors may hold cash, but they may not sell short, with focus on quarterly portfolio rebalancing. They measure portfolio performance monthly and exclude trading frictions. Using common stock/exchange-traded fund (ETF) trading records for 20,622 individual Belgian brokerage accounts during January 2003 through March 2012, they find that:

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Do short-term trade ideas of professional stock analysts have merit? In their July 2019 paper entitled “Are Analyst Trade Ideas Valuable?”, Justin Birru, Sinan Gokkaya, Xi Liu and René Stulz examine the price impact of analyst trade ideas, which differ from stock ratings in that trade ideas:

1. Have horizons of only one week to three months.
2. Reflect expected short-term price changes in response to upcoming news (firm catalysts) or short-term overreaction/underreaction to recent news (temporary mispricing).
3. May be opposite in direction from the analyst’s rating on a stock.
4. Are typically issued on days with no firm news and no other analyst reports.

They estimate abnormal returns of trade ideas based on an equally weighted portfolios of stocks with similar size, book-to-market ratio and momentum characteristics. For trade idea buy and sell portfolios, they add a new stock at the close on the trading day after idea announcement and rebalance the portfolio on any day a stock is added or removed. Using a manually constructed sample of 4,167 buy ideas and 367 sell ideas from 688 analysts at 77 brokers involving 1,619 unique stocks during 2000 through 2015, they find that: Keep Reading

Did Bill Gross, the Bond King, generate significantly positive alpha during his May 1987 through September 2014 tenure as manager of PIMCO Total Return Fund (Fund)? In their March 2019 paper entitled “Bill Gross’ Alpha: The King Versus the Oracle”, Richard Dewey and Aaron Brown investigate whether Bill Gross generates excess average return after adjusting for market exposures over this tenure. They further compare evaluation of bond market alpha for Bill Gross to evaluation of equity market alpha for Warren Buffett. Following the explanation given by Bill Gross for his outperformance, their factor model of Fund returns includes three long-only market factors: interest rate (Merrill Lynch 10-year Treasury Index), credit (Barclays U.S. Credit Index) and mortgage (Barclays U.S. MBS Index). It also includes a fourth factor that is long U.S. Treasury 5-year notes and short U.S. Treasury 30-year bonds, with weights set to eliminate coupon and roll-down effects of their different durations. Using monthly returns for the Fund and the four model factors, and monthly 1-month U.S. Treasury bill yield as the risk-free rate during June 1987 (first full month of the Fund) through September 2014 (when Gross left the Fund), they find that: Keep Reading

Given the uniqueness of fine art objects and uncertainties in demand (at auctions), can investors in paintings get accurate estimates of market values of holdings and potential acquisitions? In their March 2019 paper entitled “Machines and Masterpieces: Predicting Prices in the Art Auction Market”, Mathieu Aubry, Roman Kräussl, Gustavo Manso and Christophe Spaenjers compares accuracies of value estimates for paintings based on: (1) a linear hedonic regression (factor model), (2) neural network software and (3) auction houses. For the first two, they employ 985,188 auctions of paintings during 2008–2014 for in-sample training and 104,404 auctions of paintings during the first half of 2015 for out-of-sample testing. Neural network software inputs include information about artists and paintings (year of creation, materials, size, title and markings), and images of the paintings. Using information about artists/paintings and images and auction house estimates and sales prices for the specified 1,089,592 paintings by about 125,000 artists offered through 372 auction houses during January 2008 through June 2015, they find that:

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