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BEROC 2017-05-02 v3 (Shortened)

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Shingo Goto

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Transcript of BEROC 2017-05-02 v3 (Shortened)

Shingo Goto, Ph.D.
University of Rhode Island
`
May 2, 2017
BEROC
THANK YOU!
Academic Theories Meet The Practice of Active Portfolio Management
shingo_goto@uri.edu
shingo.goto@gmail.com
Challenges in Active Portfolio Management
Source: S&P Dow Jones Indices
(http://us.spindices.com/resource-center/thought-leadership/research/)
More than
80%
(
~90%
) of actively managed funds lag the market benchmark in a
5
year horizon!
% of US Equity Funds
Outperformed by Benchmarks
Cow Droppings
__ is more concerned with
impressing the audience
(by making
confidence sounding predictions
) than in
truth and factual accuracy
.
http://en.wikipedia.org/wiki/Bullshit
We should strive to minimize
Many finance pundits’ opinions have a lot of similarity with the following video.
[Source] Anchorman: The Legend of Ron Burgundy (2004)
"Scientific" Approaches to Investments
Scientifically-Motivated

and
EVIDENCE-BASED
investment process

by
engaging the data honestly.
Theoretically sound
Source Sensible Ideas (
Hypotheses
) from Academic Research
Empirically valid
Test the ideas within practical constraints and available resources.
An Industry Leader's Perspective

"Strategic Asset Allocation" Mix (All Weather) =
Risk Parity
Has nothing to do with directional bets.
A "Mechanical thing."

Active Bets (
Zero sum game
) + Strategic Asset Allocation

For the most current strategies, ... there is just beta you know about, and beta you don’t understand yet, and no clear separation between the two.
Academic Leaders Say
The alpha/beta, style/selection, active/passive, skill/index paradigm has become meaningless.
The “Style/Factor” choice is now the main, hard, and only portfolio problem.

Recent cutting-edge textbooks are based on systematic
Factor Investing
approaches.
John Cochrane,
Efficient Markets Today
http://faculty.chicagobooth.edu/john.cochrane/research/papers/Cochrane_efficient_markets.doc
Guiding Principles for Active Portfolio Management
Even if the stock market were perfectly
EFFICIENT w.r.t. INFORMATION
, this would NOT imply that the market benchmark is
MEAN-VARIANCE EFFICIENT
.
Picking stocks are difficult. But we can still improve the portfolio's
MEAN-VARIANCE EFFICIENCY
through
Efficient DIVERSIFICATION
(
Efficient Risk Control
)
.
Recent research have found
FACTORS/SIGNALS
that give us
slightly favorable odds
to beat the market.
Where Academic Research Insights Meet the Practice
Government Pension Funds of Norway, CalPERS, etc. are among the leaders in Factor Investing.
Base Chart was due to INTECH.
A Synthesis: Opportunities for Active Portfolio Mgmt.
Efficient Divsificartion and Risk Control
Harvesting Factor Risk Premiums
An "Ideal" Portfolio
Risk-based Asset Allocation
From Davis (2008), Dimenstional Fund Advisors
Ex Ante Frontier
should be much
narrower
than what we can construct from historical data (ex post frontier).
Portfolio optimization is useful for
reducing portfolio

risk
and
improving the Sharpe ratio
out-of-sample.
A Challenge in Equity Investing
From an experience of teaching student-managed portfolio.
An Interesting Experience w/ Students
Even the most skillful investors (e.g.
Warren Buffett
) can make correct calls only
55-60%
of the time. Our hit ratios must be much lower.
Real World Challenges in Investment Management
How should we design a portfolio strategy to take advantage of the
slightly favorable odds
?
US public sec. markets are
"mostly" efficient
.

Active
management is a
zero-sum game
.
Our research may still find an idea that has a
slightly favorable odds
to beat the market.
Portfolio 123 Example: Betting Against Firms with Large External Financing
( Equity Repurchase - Equity Issuance + LT Debt Reduction - LT Debt Issuance) / Total Assets
Firms with small (more negative) external financing have performed better than those with large external financing.
(Large Cap Universe)
Harvesting Factor Premiums
Fama & French Factors
Market
return - Risk-free rate
HML
: High Bk/Mkt Minus Low B/M (
Value
)
SMB
: Small Minus Big (
Size
)
RMW
: Robust Minus Weak
Profitability
.
CMA
: Conservative Minus Aggressive
Investments
.

Average Monthly Excess Returns of 5x5 Portfolios Formed on Size and B/M
Stocks with high B/M ratios ("Value" stocks) tend to achieve higher returns than those with low B/M ratios ("Growth" stocks), especially among smaller stocks.
Source: Calculated for 1971-2014 using data available from Prof. Ken French's website.
Portfolio 123 Example: Betting on Firms with Large Net Cash Positions
( Cash & Cash Equivalents - ST Debt ) / Total Assets
Firms with large net cash positions have performed better than those with small net cash positions.
(S&P500 Universe)
In March 2013, we bought
154
shares of Questcore Pharmaceuticals (
QCOR
) at
$35.70
per share.
QCOR
lost its value by
23.5%
in 3 weeks! We observed a lot of
short-selling
activities.
We decided to stick to the model and hold the stock.
Fortunately,
the short-sellers proved wrong
.
Our portfolio benefited from the QCOR price appreciation.
We sold about
66
shares of
QCOR
at
$79.41
,
to reduce the portfolio weight of the stock.
We still held
88
shares.

However,
QCOR
price
fell sharply
(by
24%
) later, when
Citron Research
(a short-seller) alleged fraud of the company's main drug product (Acthar).

We had to decide what to do with the
88
remaining shares.
We decided to
sell
the
88
shares in light of the allegation.
We sold at
$63.06
.
Textbooks and Lectures provide little guidance to real world investment decisions.
However, the
QCOR
price
surged again
due to an acquisition by Mallinckrodt.
Missed profit opportunities
(Ouch!).
Portfolio Math Refresher
Portfolio risk (volatility)
Portfolio Risk Decomposition (Attribution)
From my teaching note (a handout).
Portfolio Risk Contribution of Each Asset
Marginal Risk Contribution (MRC)
Total Risk Contribution (TRC)
TRC[i] = weight[i] x MRC[i]
% Risk Contribution (%RC) = Risk Budget
TRC[i] / Sum of All TRCs
These concepts naturally extend to other popular linearly homogenous risk measures, such as
Value at Risk
and
Expected Shortfall
.
Final Remarks
The
Science of Investing
(Academic Researh) and the
Practice of Investing
(by leading institutions) have become very close at the Frontier of investment management.
Great news for researchers and students.
Wanted to Study Finance More ...

Quit Sumitomo to pursue graduate studies in the USA

Let's Move On ...
A quick overview
Recent
academic view
on investment mgmt and its
practical implications.

We will NOT discuss the following today:
Pointing to a fast growing segment in asset mgmt industry and its interaction w/ academic research.
Effects of taxes, regulations, etc.
Dynamic asset allocation
issues.
Theoretically (and mathematically) interesting, but practically difficult.
We stick to the familiar
Markowitz mean-variance framework
.
E[R]-Rf
Volatility of R
Optimal Portfolio of Risky Asset
Global Min. Var. Portfolio
Risk-free asset
Mean-Variance Portfolio Analysis
Academic Research:
Efficient Risk Control
Improves
Out-of-Sample
Portfolio Performance
Leading Industry Practice Sparks
Research Interests
Ang, Goetzmann, & Schaefer (2009) study for Norwegian Government Pension Fund.
Active managers/strategies have added value.
This added value can be attributed to premiums for factor exposures (
"factor betas"
), which arise (unintentionally) from
bottom-up strategy/manager selection
.
Ref: Robeco's presentation.
Recommends
"Top-Down"
approach to harvest factor premiums more intentionally and efficiently.
A Case Study: Fund Performance Analysis w/ Fama-French New 5 Factor Model
Invests in
40
mid- to large-size stocks, focusing on:
Environmental, Social, & Governance (ESG).
http://online.barrons.com/news/articles/SB51885783724964273656104580136401822702186?mod=WSJ_qtnews_wsjlatest
Parnassus Core Equity fund (PRBLX)

PRBLX Example Continued
PRBLX
vs
Market
Higher average return
Lower volatility
Higher Sharpe Ratio

Beating
97%
of its peers in the large-blend cagegory.
Beta = 0.733
Significant Alpha (Outperformance)
,
2.56% annualized (t=2.33)
PRBLX Example (Last)
PRBLX
has no exposure to Size (SMB) or Value (HML) factors.
PRBLX
has
significant exposures
to
Profitability (RMW)
and
Investment (CMA)
factors.
RMW
and
CMA
exposures subsume
PRBLX
's
Alpha
(no longer significantly from zero).
Please take a glance at the handout
"Academic Theories Meet The Practice of Active Portfolio Management''
for more technical introduction.
Questions & Discussions Welcome.
Investors' Indifference Curve
Employs a wide range of criteria, including workplace policies, board diversity, greenhouse-gas emissions, and water usage.
PRBLX
's out-performance comes from investing in
profitable firms w/ low asset growth
(not necessarily from its ESG focus).
Feedbacks to Academic Research
A Quick Introduction to Active Equity Investment

Example: Global Sector Allocation
Academic Research and the Practice of Active Portfolio Management
Equalize MRCs:
Global Minimum Variance Portfolio (GMVP)
Equalize (MRC/Volatility)'s = Equalize Correlations w/ the Portfolio:
Maximum Diversification Portfolio
Equalize TRCs (Risk Budgets):
Risk Parity Portfolio
Risk-Controlled Portfolio Examples
Global Sector Allocation with Long-Only Constraints
Long-Run Performance of
Risk-Controlled Portfolios
Sample Period: Jan 1997 - December 2010
[Video Suppressed]
Video Interview - Ray Dalio @ Bridgewater Associates
[Suppressed]
Full transcript