1
Q
Advantages investing in own stock
A
- Companies have incentives to stimulate employees to invest pension money in company stock.
- Increase employee effort
- Source of financing
- Stable shareholder base
2
Q
Disadvantages investing in own stock
A
- Employees holding company stock face huge risks.
- When company goes badly, you may not just lose your income but also your pension assets! (e.g. Enron)
- Employee and company incentives are NOT aligned!
- Evidence of under-diversification. High idiosyncratic risk! Causes:
+ Behavioral Biases (e.g. overconfidence regarding firm-specific information)
+ Lack of Investment knowledge (Less sophisticated investors diversify less)
3
Q
Techniques for achieving alpha
A
- Taking more/less risk (measured by beta)
- Tilt their portfolios to “priced characteristics” (include factors)
+ Small stocks earn a premium relative to Large stocks -> Size Premium
+ Value stocks earn a premium relative to growth stocks -> Value Premium
+ Recent winners earn a premium relative to past losers -> Momentum Premium
4
Q
How to detect superior active managers?
A
- Past performance (while limited, there is some persistence)
- Business cycle (some managers do better in specific economic circumstances, and in a predictable way)
- Passive, tailor-made index funds
- Manager Characteristics
- Holdings analysis
5
Q
What are manager characteristics?
A
- Higher SAT > Better performance
- Lower fees > Better performance
- Skin in the game > Better performance
- Better university > Better performance
6
Q
Holdings analysis to outperform
A
- Bigger active positions > Outperform
- Funds that change risk > Underperform
- Contrarian managers by holdings > Outperform
7
Q
Reality of active funds
A
- Active underperforms passive, especially on long term
- Average active fund has negative alfa
- Almost no performance persistence in active funds
- Low-cost funds beat high-cost funds (Terminal wealth ratio)
- Some active funds tend to outperform during recessions (but they miss the recovery)
8
Q
Types of equity
A
- Domestic Equity
i. Large Caps for broad market exposure
ii. Smart beta strategies (small cap, value, growth, quality, low volatility,…) - International Equity (for diversification)
- Emerging/frontier equity
9
Q
Safe assets
A
- Money market
i. Real interest rate or “Reinvestment” risk!
ii. Not attractive at current low yields (even below inflation!) - Long-term nominal bonds
i. Inflation-Risk! Can’t hedge main risk of long-term investors (loss of purchasing power)
ii. Long-term bonds -> high duration -> high exposure to interest rate hikes - Inflation-linked bonds:
i. No reinvestment risk
10
Q
Solution to not give much asset flexibility
A
Create one-size-fits-all asset allocation: each participant gets the same allocation.
- Collective benefits of near-optimal allocation outweigh the costs across possible suboptimal allocations
- The more homogeneous the group is (e.g. same age), lower the costs with imposing a default allocation.
- Many European second-pillar pension systems work exactly like this.
11
Q
Solution to not give much asset flexibility - alternative 1
A
- Propose a default allocation, but allow participants to deviate from it.
- Past experience: great majority will go for default and will not deviate - Deviations:
+ Limited flexibility: go for slightly more defensive of aggressive
+ Full flexibility: allow any combination of assets (from the available menu)
12
Q
Solution to not give much asset flexibility - alternative 2
A
- Group individuals in homogeneous groups (e.g. same age)
- Have default allocation for all members within the group.
- Main idea behind “life cycle funds”
- Allocation changes as cohort gets older
13
Q
Why allocation may change?
A
- You may want to change the asset mix as your views on the market change -> market timing
- You as an individual may change, hence also your optimal allocation
- Some assets may outperform, others may underperform -> should we rebalance back to initial weights?
14
Q
What individual characteristics may change allocation?
A
- Human capital
- Liquidity needs
- Risk aversion/capacity
- Labor flexibility
15
Q
Mechanical rebalancing
A
- Contrarian Strategy <> You sell recent winners, and buy recent losers
- A bad active strategy that don’t account for information and only for time (e.g. annual rebalance)
- Evidence show bigger loses in crisis
16
Q
Strategic rebalancing
A
- Account for trends. If the trend is negative, delay the rebalancing. (so you won’t end buying
something that will lose value) - Evidence show a reduction of losses in crisis compared to mechanical rebalancing
Global Asset Management
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Decks in class (4)
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