Recent Research: Highlights from June 2012
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"Some Like It Hot: The Role of Very Active Mandates across Equity Segments in a Core-Satellite Structure"
The Journal of Investing (Summer 2012)
Frank Nielsen, Giacomo Fachinotti, and Xiaowei Kang
This article reviews the active management opportunity in different market segments, and discusses the role of very active mandates across segments in a core–satellite portfolio structure. Research based on manager performance data over the last 10 years indicates that there is little evidence that average emerging market or small-cap managers have produced higher or more persistent risk-adjusted returns relative to their developed market large-cap peers. Therefore, institutional investors may consider active and passive management as complementary strategies across all equity segments. Due to the outperformance of high active risk mandates over the analyzed period, a simulated core–satellite structure across different equity segments achieved a higher information ratio than a combination of low active risk managers. The outperformance of high active risk mandates may reflect links between higher manager skill, higher investment conviction, and/or fewer constraints. Depending on investment beliefs, institutional investors might explore such a core–satellite structure to implement the global equity allocation.
"Indices in Institutional Investment Management: Results of a European Survey"
The Journal of Index Investing (Summer 2012)
Noel Amenc, Felix Glotz, and Lin Tang
The authors collected 104 responses, representing investors from asset management companies, pension funds, and insurance firms all over Europe. The survey finds that liquidity, objectivity, and transparency are the most important criteria investors have for indices. Buy-and-hold characteristics are not requirements for an index, signifying a break with the traditional conception of indices, which sees the extremely low turnover as a distinguishing characteristic between passive and active investments. This finding has strong implications, as it suggests that any liquid and systematic methodology could be adopted for index construction. In terms of specific requirements for indices in different asset classes, the authors find that although subsegment indices (e.g., for styles, sectors, and so on) play a subordinate role in equity investing compared to broad market indices, subsegment indices are far more popular for bonds. Concerning the recently introduced alternative weighting schemes, index providers have paid much attention to developing alternative weighting schemes for equity; however, the adoption rate of alternative weighting schemes for bond indices is quite low at the same time the dissatisfaction with bond indices is actually higher than with equity indices, and investors perceive numerous important problems with standard bond indices.
"Optimal Investments in Structured Bonds"
The Journal of Derivatives (Summer 2012)
Pernille Jessen and Peter Lochte Jorgensen
Structured investment vehicles for retail customers have become increasingly prevalent, and also increasingly complex. Yet numerous articles have shown that many popular structures offer rather poor performance for the buyer, relative to the expected payoff and to the cost of producing that payoff with a combination of simpler derivative contracts. Retail investors seem to like payoffs resembling that of a protectiveput strategy very much, with exposure on the upside but limited risk of loss on the downside. Why should they be willing to pay more for such products than they are worth? In this article, Jessen and Jørgensen show that such structured products can make sense for an investor with an ordinary utility function if the diversification value of exposure to the underlying index is great enough and the structured product is the only way they can obtain exposure to that index.
"Follow-On Financings of Portfolio Companies: Issues for Investors and Start-Up Companies"
The Journal of Private Equity (Summer 2012)
Venture capitalists who invest in the first round of start-up companies eventually have to decide which companies they will continue to fund. A typical investor in these early stages, especially in medical device and bio/pharmaceutical companies, will expect to write off 20% to 30% of all investments. It is a much more efficient use of capital when this write off occurs after just one investment, when the dollars at risk are usually modest. In this article, the author describes the issues involved in making follow-on investing decisions and suggests how the process can work more effectively for venture capital partnerships and for portfolio companies.