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Recent Research: Highlights from Summer 2014

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"Return Predictability and Dynamic Asset Allocation: How Often Should Investors Rebalance?"
The Journal of Portfolio Management (Summer 2014
Himanshu Almadi, David E. Rapach, and Anil Suri

To exploit return predictability via dynamic asset allocation, investors face the important practical issue of how often to rebalance their portfolios. More frequent rebalancing uses statistically and economically significant short-horizon return predictability to aggressively pursue the dynamic investment opportunities afforded by changes in expected returns. However, the degree of return predictability typically appears stronger at longer horizons, which, along with lower transaction costs, favors less frequent rebalancing. The authors analyze the performance effects of rebalancing frequency in the context of dynamic portfolios constructed from monthly, quarterly, semi-annual, and annual return forecasts for US stocks, bonds, and bills, where the dynamic portfolios rebalance at the same frequency as the forecast horizon. Along the transaction-cost/rebalancing frontier, monthly (annual) rebalancing provides the greatest outperformance when unit transaction costs are below (above) approximately 50 basis points, and dynamic portfolios based on annual rebalancing typically outperform the benchmarks for unit transaction costs well in excess of 400 basis points.

"Oversight and Due Diligence: Independent Credit Risk Managers and Trust Oversight in RMBS Transactions"
The Journal of Structured Finance (Summer 2014)
Ron D’Vari, Andrea Bryan, Asim Ali, and Michael Grogan

In structured finance transactions, a trustee works collaboratively with the issuer and servicer to protect the financial interest of the investors. Large investors have been lobbying for residential mortgage-backed securities (RMBS) trustees to take on a more direct role to ensure that initial collateral conforms to the representations and warranties, put-back rights under the securitization’s reps and warranties are exercised properly, all loan documentation is properly executed and transferred, servicers are performing their duties, and adequate transparency is provided to the investors. RMBS trustees, however, are not currently equipped to handle any of these functions. Given the market and technical expertise required in the mortgage securitization arena, trustees could benefit from partnering with or retaining the services of an independent credit risk manager (CRM) steeped in a high degree of domain knowledge related to evaluation, modeling, stress testing, regulatory reporting, and complex asset credit underwriting. This article seeks to explain the role an independent CRM can provide in securitization of residential mortgages, with a specific focus on governance.

"Diversification versus Concentration Motives in Mutual Fund Mergers"
The Journal of Wealth Management (Summer 2014)
Aymen Karoui and Maher Kooli

This study examines the commonality between characteristics of acquirers and those of targets in mutual fund mergers. A positive and significant commonality would align with acquirers targeting similar funds and thus expecting further concentration in their segment. An opposite result would lend credence to the hypothesis that acquirers aim to diversify away from their original characteristics. Our empirical results show that acquirers and targets share positively correlated total net assets, expenses, turnover, and age, whereas they exhibit nonsignificant correlations in performance and flows. Thus, the potential for diversification could stem from the latter two characteristics. We then test whether the differences between the characteristics of acquirers and targets predict the post-merger performance of the acquirers. We find that acquirers that target funds with poorer performance, higher turnover, and higher expense ratios exhibit a decrease in their post-merger performance.

"When Should You Claim Social Security?"
The Journal of Retirement (Summer 2014)
David Laster and Anil Suri

When to claim Social Security is for many retirees among the most important financial decisions they will make. For many families, the lifetime expected value of future Social Security benefits exceeds half a million dollars. Waiting until age 70 to claim Social Security can raise one’s monthly benefit check by up to 76%, yet only about 1 in 20 recipients waits until age 67 or older. Delayed claiming offers two key advantages. First, by raising the level of guaranteed lifetime income, it can help reduce the risk of outliving one’s wealth. Second, for many people, waiting to claim can increase expected lifetime benefits. For individuals of average life expectancy, waiting until age 69 or 70 can boost expected lifetime benefits by 14%, or $60,000 for those with high (90th percentile) income. Waiting to claim can be even more beneficial for high-income couples, potentially increasing their expected lifetime benefits by more than 20%, or $150,000.

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