Recent Research: Highlights from November 2011
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"Breadth, Skill, and Time"
The Journal of Portfolio Management (Fall 2011)
Richard C. Grinold and Ronald N. Kahn
The information ratio determines the potential of an investment process to add value, and according to the fundamental law of active management, adding value depends on a combination of skill and breadth. Grinold and Kahn use an equilibrium dynamic model to provide insight into the concept of breadth, as well as a refined notion of skill. In equilibrium, the arrival rate of new information exactly balances the decay rate of old information. Grinold and Kahn denote the information turnover rate g. It is relatively easy to measure for any investment process. If the investment process forecasts returns on N assets, the breadth of the strategy i is g · N. Skill—the correlation of forecasts and returns—increases with the return horizon for small horizons, but then asymptotically decays to zero for very long horizons. The authors’ main result is that the ex ante information ratio is , where κ is a measure of skill.
"Investment Management Is Risk Management—Nothing More, Nothing Less"
The Journal of Wealth Management (Winter 2011)
In this article, we argue that investors and investment managers are making a mistake if they try to focus on achieving high returns or high risk-adjusted returns and are likely to disappoint investors in the long run. Instead we argue that investment management should almost exclusively focus on managing the risks of an investment portfolio with above average returns being a natural outcome of a proper risk management process. We describe the most important risk management steps and why we believe this process leads to superior investment performance.
How Loan-Level Insight Can Lead the Way to Resolving the RMBS Crisis
The Journal of Structured Finance (Fall 2011)
Brendan J. Keane
This article demonstrates the effectiveness of granular portfolio analysis versus deal-level portfolio analysis by applying each approach across two issues that continue to vex the non-agency RMBS market: the adequacy of seller-provided representations and warranties of loan quality and valuation techniques that can effectively reveal the hidden intricacies of loan performance and resulting RMBS bond cash flows. The article also illuminates how this methodology can be done as quickly, painlessly, and efficiently as traditional “higher level” portfolio evaluations.