New Developments in Long-Term Asset Management

The NBER's conference on New Developments in Long-Term Asset Management took place May 9-10 in Cambridge. Research Associates Monika Piazzesi of Stanford University and Luis M. Viceira of Harvard University organized the meeting, sponsored by Norges Bank Investment Management. These researchers' papers were presented and discussed:

Matthew Backus, Columbia University and NBER; Christopher Conlon, New York University; and Michael Sinkinson, Yale University and NBER

Common Ownership in America: 1980-2017 (NBER Working Paper No. 25454) (slides)

When competing firms possess overlapping sets of investors, maximizing shareholder value may provide incentives that distort competitive behavior, affecting pricing, entry, contracting, and virtually all strategic interactions among firms. Backus, Conlon, and Sinkinson propose an approach to the measurement of this phenomenon for the universe of S&P 500 firms between 1980 and 2017. Over this period, the incentives implied by the common ownership hypothesis have grown dramatically. Contrary to popular intuition, this is not primarily associated with the rise of BlackRock, Vanguard, and State Street: instead, the trend in the time series is driven by a broader rise in diversified investment strategies, of which these firms are only the most recent incarnation. In the cross section, there is substantial variation that can be traced, both in the theory and the data, to observable firm characteristics - particularly the share of the firm held by retail investors. Finally, the researchers show how common ownership can theoretically give rise to incentives for expropriation of undiversified shareholders via tunneling, even in the Berle and Means (1932) world of the "widely held firm."

Andra C. Ghent, University of Wisconsin, Madison

What's Wrong with Pittsburgh? Delegated Investors and Liquidity Concentration (slides)

What makes an asset institutional-quality? Ghent proposes that one reason is the existing concentration of delegated investors in a market through a liquidity channel. Consistent with this intuition, they document differences in investor composition across U.S. cities and shows that delegated investors concentrate investments in cities with higher turnover. Ghent then calibrates a search model showing how heterogeneity in liquidity preferences makes some markets more liquid even when assets have identical cash flows. The calibration indicates that commercial real estate commands an illiquidity premium of two percentage points annually relative to a perfectly liquid asset with similar credit risk.

Aleksandar Andonov, University of Amsterdam; Roman Kräussl, University of Luxembourg; and Joshua Rauh, Stanford University and NBER

The Subsidy to Infrastructure as an Asset Class (NBER Working Paper No. 25045) (slides)

Andonov, Kräussl, and Rauh investigate the characteristics of infrastructure as an asset class from the perspective of a limited partner. The stream of cash flows and riskiness of performance delivered by private infrastructure funds to institutional investors is very similar to that delivered by other types of private equity, as reflected by the frequency and amounts of net cash flows as well as by the volatility of performance measures. Public investors, such as public pension funds, government agencies, and sovereign wealth funds perform worse than private institutional investors in their infrastructure fund investments, although they are exposed to underlying deals with very similar project stage, concession terms, ownership structure, industry, and geographical location. By selecting funds that invest in projects with poor financial performance, public investors have created an implicit subsidy to infrastructure as an asset class, which Andonov, Kräussl, and Rauh estimate at a minimum of $1.3-$1.5 billion per year if the alternative opportunity is the S&P 500 or real estate funds, $3.3 billion per year if compared to listed infrastructure funds, and $8.5 billion per year if compared to private equity buyout funds. The public subsidy is not primarily driven by local investments.

Lubos Pastor, University of Chicago and NBER; Robert F. Stambaugh, University of Pennsylvania and NBER; and Lucian A. Taylor, University of Pennsylvania

Fund Tradeoffs (NBER Working Paper No. 23670) (slides)

Pastor, Stambaugh, and Taylor derive equilibrium relations among active mutual funds' key characteristics: fund size, expense ratio, turnover, and portfolio liquidity. Portfolio liquidity, a concept introduced here, depends not only on the liquidity of the portfolio's holdings but also on the portfolio's diversification. As their model predicts, funds with smaller size, higher expense ratios, and lower turnover hold less-liquid portfolios. Additional model predictions are also supported empirically: Larger funds are cheaper. Larger and cheaper funds trade less and are less active, based on their novel measure of activeness. Better-diversified funds hold less-liquid stocks; they are also larger, cheaper, and trade more.

Mikhail Chernov, University of California at Los Angeles and NBER; Lars A. Lochstoer, University of California at Los Angeles; and Stig Lundeby, Norwegian School of Economics

Conditional Dynamics and the Multi-Horizon Risk-Return Trade-off (NBER Working Paper No. 25361) (slides)

Chernov, Lochstoer, and Lundeby propose testing asset-pricing models using multi-horizon returns (MHR). MHR serve as powerful source of conditional information that is economically important and not data-mined. The researchers apply MHR-based testing to linear factor models. These models seek to construct the unconditionally mean-variance efficient portfolio. They reject many popular models that deliver high maximum Sharpe ratios in a single-horizon setting. Model misspecification manifests itself in strong intertemporal dynamics of the factor loadings in the SDF representation.

Ralph S. J. Koijen, University of Chicago and NBER; Robert J. Richmond, New York University; and Motohiro Yogo, Princeton University and NBER

Which Investors Matter for Global Equity Valuations and Expected Returns? (slides)

It is common practice to decompose levels and variation in prices into expected future returns and fundamentals. However, it is unclear what information investors use for prices to be informative and how important different investors are for incorporating information into prices. Koijen, Richmond, and Yogo show that a small set of characteristics explains the majority of the variation in a panel of firm-level valuation ratios across countries. To measure how investors' demands respond to the characteristics and prices, they estimate a demand system in Great Britain and in the United States. The demand system allows the researchers to quantify the importance of different institutional types (e.g., mutual funds, broker dealers, ...) in the price formation process by computing counterfactual prices if a particular type were to follow a passive market indexing strategy.

Robin Greenwood, Harvard University and NBER, and Annette Vissing-Jorgensen, University of California at Berkeley and NBER

The Impact of Pensions and Insurance on Global Yield Curves (slides)

Greenwood and Vissing-Jorgensen document a strong effect of pension and insurance company (P&I) assets on the long end of the yield curve. Using data from 26 countries, the yield spread between 30-year and 10-year government bond yields is negatively related to the ratio of pension assets (in funded and private pension and life insurance arrangements) to GDP, suggesting that preferred-habitat demand by the P&I sector for long-dated assets drives the long end of the yield curve. The researchers draw on changes in regulations in several European countries between 2008 and 2013 to provide well-identified evidence on the effect of the P&I sector on yields and to show that P&I demand is in part driven by hedging linked to the regulatory discount curve. When regulators reduce the dependence of the regulatory discount curve on a particular security, P&I demand for the security falls and its yield increases. These effects extend beyond long government bonds. Greenwood and Vissing-Jorgensen's results suggest that pension discount rules can have a destabilizing impact on bond markets that reverses once rules are changed.

Arpit Gupta, New York University, and Stijn Van Nieuwerburgh, Columbia University and NBER

Valuing Private Equity Investments Strip by Strip (slides)

Gupta and Van Nieuwerburgh propose a new valuation method for private equity investments. First, they construct a cash-flow replicating portfolio for the private investment, using cash-flows on various listed equity and fixed income instruments. The second step values the replicating portfolio using a flexible asset pricing model that accurately prices the systematic risk in listed equity and fixed income instruments of different horizons. The method delivers a measure of the risk-adjusted profit earned on a PE investment, a time series for the expected return on PE fund categories, and a time series for the residual net asset value in a fund. The researchers apply the method to real estate, infrastructure, buyout, and venture capital funds, and find modestly positive average risk-adjusted profits with substantial cross-sectional variation, and declining expected returns in the later part of the sample.

Anil K. Kashyap, University of Chicago and NBER; Natalia Kovrijnykh, Arizona State University; Jian Li, University of Chicago; and Anna Pavlova, London Business School

The Benchmark Inclusion Subsidy (NBER Working Paper No. 25337) (slides)

Kashyap, Kovrijnykh, Li, and Pavlova study the impact of evaluating the performance of asset managers relative to a benchmark portfolio on firms’ investment, merger and IPO decisions. The researchers introduce asset managers into an otherwise standard asset pricing model and show that firms that are part of the benchmark are effectively subsidized by the asset managers. This "benchmark inclusion subsidy" arises because asset managers have incentives to hold some of the equity of firms in the benchmark regardless of the risk characteristics of these firms. Contrary to what is usually taught in corporate finance, they show that the value of an investment project is not governed solely by its own cash-flow risk. Instead, because of the benchmark inclusion subsidy, a firm inside the benchmark would accept some projects that an identical one outside the benchmark would decline. The two types of firms’ incentives to undertake mergers or spinoffs also differ and the presence of the subsidy can alter a decision to take a firm public. Kashyap, Kovrijnykh, Li, and Pavlova show that the higher the cash-flow risk of an investment, the larger the benchmark inclusion subsidy; the subsidy is zero for safe projects. Benchmarking also leads fundamental firm-level cash-flow correlations to rise. The researchers review a host of empirical evidence that is consistent with the implications of the model.

Panel on Quantitative Investing

Cliff Asness, AQR Capital Management, Owen Lamont, Wellington Management, and Feifei Li, Research Affiliates (slides)

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