New Developments in Long-Term Asset Management
May 19 and 20, 2016
Monika Piazzesi of Stanford University and Luis M. Viceira of Harvard Business School, Organizers
Joseph J. Gerakos, University of Chicago; Juhani T. Linnainmaa, University of Chicago and NBER; and Adair Morse, University of California at Berkeley and NBER
Asset Manager Funds
Institutional investors paid asset managers average annual fees of $172 billion between 2000 and 2012. Gerakos, Linnainmaa, and Morse show that asset managers outperformed their benchmarks by 96 basis points per year before fees, and by 49 basis points after fees. Estimates from a Sharpe (1992) model suggest that asset managers achieved out-performance through factor exposures ("smart beta"). If institutions had instead implemented a long-only mean-variance efficient portfolio over the same factors via institutional mutual funds, they would have earned just as a high, but no higher, Sharpe ratio as by delegating to asset managers. Liquid, low-cost ETFs are likely eroding the comparative advantage of asset managers. Because asset managers account for 29% of investable assets, the adding-up constraint implies that the average dollar of everyone else had a negative alpha of 49 basis points.
Ralph Koijen, London Business School, and Motohiro Yogo, Princeton University and NBER
An Equilibrium Model of Institutional Demand and Asset Prices (NBER Working Paper No. 21749)
Koijen and Yogo develop an asset pricing model with rich heterogeneity in asset demand across investors, designed to match institutional holdings. The equilibrium price vector is uniquely determined by market clearing for each asset. The researchers relate their model to traditional frameworks including Euler equations, mean-variance portfolio choice, factor models, and cross-sectional regressions on characteristics. They propose two identification strategies for the asset demand system, based on a coefficient restriction or instrumental variables, which produce similar estimates that are different from the least squares estimates. The authors apply their model to understand the role of institutions in stock market movements, liquidity, volatility, and predictability.
Alan Moreira, Yale University, and Tyler Muir, Yale University and NBER
Volatility Managed Portfolios (NBER Working Paper No. 22208)
Managed portfolios that take less risk when volatility is high produce large alphas and substantially increase factor Sharpe ratios. Moreira and Muir document this for the market, value, momentum, profitability, return on equity, and investment factors in equities, as well as the currency carry trade. They find that volatility timing produces large utility gains and benefits both short- and long-horizon investors. Their strategy is contrary to conventional wisdom because it takes less risk in recessions and crises yet still earns high average returns. This rules out typical risk-based explanations and is a challenge to structural models of time-varying expected returns.
Nathan Foley-Fisher, Federal Rerserve Board, and Borghan Narajabad and Stephane Verani, Federal Reserve Board
Securities Lending as Wholesale Funding: Evidence from the U.S. Life Insurance Industry
The existing literature implicitly or explicitly assumes that securities lenders primarily respond to demand from borrowers and reinvest their cash collateral through short-term markets. Using a new dataset that matches every U.S. life insurer's bond portfolio, as well as their lending and reinvestment decisions, to the universe of securities lending transactions, Foley-Fisher, Narajabad, and Verani offer compelling evidence for an alternative strategy, in which securities lending programs are used to finance a portfolio of long-dated assets. The researchers discuss how the liquidity and maturity mismatch associated with using securities lending as a source of wholesale funding could potentially impair the functioning of the securities market.
Ian R. Appel, Boston College, and Todd Gormley and Donald Keim, University of Pennsylvania
Standing on the Shoulders of Giants: The Effect of Passive Investors on Activism
Appel, Gormley, and Keim analyze whether the growing importance of passive investors has influenced the campaigns, tactics, and successes of activists. They find activists are more likely to pursue changes to corporate control or influence (e.g., via board representation) and to forego more incremental changes to corporate policies (e.g., via shareholder proposals) when a larger share of the target company's stock is held by passively managed mutual funds. Furthermore, higher passive ownership is associated with increased use of hostile, expensive tactics (e.g., proxy fights) and a higher likelihood the activist obtains board representation or the sale of the targeted company. Overall, the findings suggest that the increasingly large ownership stakes of passive institutional investors mitigate free-rider problems associated with certain forms of intervention and ultimately increase the likelihood of success by activists.
Assaf Hamdani, The Hebrew University, and Eugene Kandel, Yevgeny Mugerman, and Yishay Yafeh, Hebrew University
Incentive Fees and Competition in Pension Funds: Evidence from a Regulatory Experiment
Concerned with excessive risk taking, regulators worldwide generally prohibit private pension funds from charging performance-based fees. Instead, the premise underlying the regulation of private pension schemes (and other retail-oriented funds) is that competition among fund managers should provide them with the adequate incentives to make investment decisions that would serve their clients' long-term interests. Using a regulatory experiment from Israel, Hamdani, Kandel, Mugerman, and Yafeh compare the effects of incentive fees and competition on the performance of three exogenously-given types of long-term savings schemes operated by the same management companies: (i) funds with performance-based fees, facing no competition; (ii) funds with AUM-based fees, facing low competitive pressure; and (iii) funds with AUM-based fees, operating in a highly competitive environment. The main result is that funds with performance-based fees exhibit significantly higher risk-adjusted returns than other funds, but are not necessarily riskier (that depends on the measure of risk used). By contrast, the researchers find that competitive pressure leads to poor performance, and conclude that incentives and competition are not perfect substitutes in the retirement savings industry. Their analysis suggests that the pervasive regulatory restrictions on the use of performance-based fees in pension fund management may be costly for savers in the long-run and may need to be reconsidered.
Oleg Chuprinin, UNSW Australia Business School, and Denis Sosyura, University of Michigan
Family Descent as a Signal of Managerial Quality: Evidence from Mutual Funds
Chuprinin and Sosyura study the relation between mutual fund managers family backgrounds and their professional performance. Using hand-collected data from individual Census records on the wealth and income of managers' parents, the researchers find that managers from poor families deliver higher alphas than managers from rich families. This result is robust to alternative measures of fund performance, such as benchmark-adjusted return and value extracted from capital markets. The authors argue that managers born poor face higher entry barriers into asset management, and only the most skilled succeed. Consistent with this view, managers born rich are more likely to be promoted, while those born poor are promoted only if they outperform. Overall, the researchers establish the first link between family descent of investment professionals and their ability to create value.
Sergey Chernenko, Ohio State University, and Adi Sunderam, Harvard University and NBER
Liquidity Transformation in Asset Management: Evidence from the Cash Holdings of Mutual Funds
Using a novel data set on the cash holdings of mutual funds, Chernenko and Sunderam show that cash plays a key role in how mutual funds provide liquidity to their investors. Consistent with the idea that they perform a significant amount of liquidity transformation, mutual funds use cash to accommodate inflows and outflows rather than transacting in equities or bonds, even at long horizons. This is particularly true for funds with illiquid assets and at times of low market liquidity. The researchers provide evidence suggesting that, despite their size, the cash holdings of mutual funds are not sufficiently large to fully mitigate price impact externalities created by the liquidity transformation they engage in.
Andrea Eisfeldt, University of California at Los Angeles and NBER; Hanno Lustig, Stanford University and NBER; and Lei Zhang, University of California at Los Angeles
Risk and Return in Segmented Markets with Expertise
Complex assets appear to earn persistent high average returns, and to display high Sharpe ratios. Despite this, investor participation is very limited. Eisfeldt, Lustig, and Zhang provide an explanation for these facts using a model of the pricing of complex securities by risk-averse investors who are subject to asset-specific risk in a dynamic model of industry equilibrium. Investor expertise varies, and the investment technology of investors with more expertise is subject to less asset-specific risk. Expert demand lowers equilibrium required returns, reducing participation, and leading to endogenously segmented markets. Amongst participants, portfolio decisions and realized returns determine the joint distribution of financial expertise and financial wealth. This distribution, along with participation, then determines market-level risk bearing capacity. The researchers show that more complex assets deliver higher equilibrium returns to expert participants. Moreover, the researchers explain why complex assets can have lower overall participation despite higher market-level alphas and Sharpe ratios. Finally, they show how complexity affects the size distribution of complex asset investors in a way that is consistent with the size distribution of hedge funds.