iShares and the US Market Risk Exposure

Abstract:  Previous researchers find that country iShares are directly and strongly exposed to US market risk in addition to home country market risk. This finding contradicts the fact that by design these iShares should behave as their underlying market indices behave. With monthly data and the appropriate orthogonalization choice, we find that direct US market risk exposure is weaker, less significant and less prevalent than previously suggested. Further tests indicate that in fact a strong majority of country iShares do not behave significantly differently from their underlying market indices. Hence, they are not less effective as diversification instruments to US investors than direct investments in the foreign markets as represented by their underlying market indices.     

Risk Exposures and International Diversification: Evidence from iShares

Abstract:   We examine the newly developed international diversification instruments–iShares traded on the American Stock Exchange. Given the fact that iShares can be created and redeemed at will, the daily price of an iShare is expected to be equal to the daily portfolio value of the underlying assets in the home‐country market. Therefore, theoretically, iShare pricing should be influenced by the risk from the iShare's home‐country market and not the risk from the US market, per se . We evaluate the risk exposure of iShare prices to the US market (non‐fundamental effect) as well as the home‐country market (the fundamental effect). We find that most iShare returns are significantly influenced by and sensitive to the US market risk. Moreover, the US market appears to be the key permanent driving factor and the home‐country market is a pronounced transitory driving force for iShare prices. These findings indicate the presence of limits of international arbitrage for iShares. As a result, the international diversification benefits of iShares become questionable.     

MARKET SEGMENTATION AND INTERNATIONAL ASSET PRICES: EVIDENCE FROM THE LISTING OF WORLD EQUITY BENCHMARK SHARES

This article provides an empirical analysis of the announcement effect of the listing of the seventeen World Equity Benchmark Shares (WEBS) on the returns of the corresponding market index returns and closed‐end country fund premiums. I find that the announcement of the listing of the WEBS resulted in a positive market price reaction for the market indexes. Furthermore, there was a significant decline in premiums for closed‐end country funds. The findings are consistent with models of international asset pricing under market segmentation and they illustrate that the listing of internationally tradable securities is an effective mechanism for integrating international capital markets. JEL classification: G14, G15     

On the premiums of iShares

We show that the newly developed exchange-traded world equity index funds, or iShares, trade at economically significant premiums for 10–50% of the times even after controlling for transaction costs and time-zone measurement errors. Moreover, iShares price returns exhibit excessive volatility relative to their NAV returns. These findings suggest a limit of arbitrage in the international iShares market where iShares can be created and redeemed at will and premiums that exceed the creation/redemption transaction costs should be immediately arbitraged away. However, our cointegration and persistence profile analyses indicate that the deviations of most iShares' prices from their NAVs are not persistent and converge to zero within two days. We propose several rational factors to explain the absolute value of iShares premiums. The panel regression results suggest that institutional ownership, bid–ask spread, trading volume, exchange rate volatility, political and financial crises and, to a lesser extent, the conditional correlation between the U.S. and home markets are the significant driving factors of the size of iShares premiums. However, a significant variation of the premiums still remains unexplained, which suggests that behavioral factors may account for some mispricing.     

The Performance Persistence of Closed-End Funds

The purpose of this study is to extend the research on mutual fund performance persistence to net asset value and market price performance of domestic closed‐end funds. While research has assessed the performance persistence of open‐end mutual funds, it has not assessed the performance persistence of closed‐end funds. Yet, the unique characteristics of closed‐end funds allow stronger arguments for their persistence than the arguments previously submitted for open‐end mutual funds. The results show evidence for risk‐adjusted performance persistence.     

The Secondary Market for Hedge Funds and the Closed Hedge Fund Premium

Rational theories of the closed‐end fund premium puzzle highlight fund share and asset illiquidity, managerial ability, and fees as important determinants of the premium. Several of these attributes are difficult to measure for mutual funds, and easier to measure for hedge funds. This paper employs new data from a secondary market for hedge funds, discovers a closed‐hedge fund premium that is highly correlated with the closed‐end mutual fund premium, and shows that the closed‐hedge fund premium is well explained by variables suggested by rational theories. Sentiment‐based explanations do not find support in the data.     

Price Performance Following Share‐Repurchase Announcements by Closed‐End Funds

We investigate the price performance of closed‐end funds that announce share‐repurchase programs. Closed‐end funds experience positive average stock‐price reactions to the announcements. The long‐run buy‐and‐hold abnormal returns of repurchasing funds over the subsequent three years are significantly higher than a nonrepurchasing control sample matched by size, type, investment style and geographic diversification. Funds with larger discounts, international funds, equity funds, and funds that announce larger repurchases or frequently announce repurchases, experience more positive stock‐price reactions. Except for larger repurchases, the same characteristics are associated with more positive long‐run buy‐and‐hold returns.     

A MULTIFACTOR ANALYSIS OF COUNTRY FUND RETURNS

Previous closed‐end country fund research concludes that returns behave more like the U.S. market than like their target markets. We argue this finding may be biased by model misspecification and inappropriate estimation techniques. We propose a single‐equation model containing five hypothesized factors of fund returns. We estimate this model for nineteen pooled seasoned funds using a time‐series cross‐section regression that corrects for two types of autocorrelation. We show that returns are strongly related to target markets. Returns are also related to changes in discounts, exchange rates, and other countries' markets, but are only weakly related to the U.S. market. JEL classification: G10, G12     

Closed-End Fund Expenses and Investment Selection

Investment returns on closed‐end funds are highly volatile. Because expenses have a definite negative impact on closed‐end fund returns, investors should include the expense ratio as a criterion for fund selection in addition to performance, investment objective, and risk of the fund. This paper constructs a model of the expense ratio of closed‐end funds to explain cross‐sectional differences in the expense ratios for the period between 1989–1996. We relate closed‐end fund expenses to fund characteristics and identify the factors that can help investors choose low expense closed‐end funds.     

Stochastic Dominance Analysis of iShares

Abstract

Country indices as represented by iShares exhibit non-normal return distributions with both skewness and kurtosis. Earlier studies provide procedures for determining the statistical significance of stochastic dominance measures and the Sharpe Ratio. This present study uses these refinements to compare the performance of 18 country market indices. The iShares are indistinguishable when using the Sharpe Ratio as no significant differences are found. In contrast, stochastic dominance procedures identify dominant iShares. Although the results vary over time, stochastic dominance appears to be both more robust and discriminating than the CAPM in the ranking of the iShares.     

Motivation and Performance of Seasoned Offerings by Closed-End Funds

We examine the motivation and performance of closed‐end funds that engage in seasoned public or rights offerings. We find that closed‐end funds are more motivated to engage in seasoned offerings when their shares exhibit a relatively high premium (compared to their corresponding NAV) and have a high degree of liquidity. We also find a significant negative valuation effect on average in response to seasoned offerings by closed‐end funds. Our cross‐sectional analysis reveals that the valuation effect at the time of the seasoned offering is more unfavorable for funds that have relatively high expense ratios and are relatively large. Furthermore, we find that the closed‐end funds experience significant negative valuation effects over the three‐year period subsequent to the seasoned offering, implying poor post‐offering performance.     

The performance of global bond mutual funds

This paper studies the risk and return characteristics of global bond mutual funds during 1988–95. These actively managed funds did not demonstrate superior performance, net of expenses, against a wide range of benchmarks and performance was negatively related to fund expenses. During the sample period, returns on global bond funds were sensitive to exchange rate movements, even after controlling for local currency returns on country bond indices. The funds had high exposure to the European, the Canadian, and the US bond markets and were least sensitive to the Japanese Bond index and movements in Japanese Yen. The funds did not outperform a US Bond index, suggesting that expenses might have outweighed diversification benefits during the sample period.     

Emerging Market Exposures and the Predictability of Hedge Fund Returns

We examine emerging market and global macro hedge funds and find a significant positive relation between hedge funds’ future returns and their exposure to both emerging market equities and emerging market currencies. We present evidence that the strong predictive power of emerging market betas is related to the superior market‐timing ability of these fund managers. Results are robust after controlling for commonly used hedge fund factors, the emerging market equity index, lagged fund returns, liquidity risk, and fund characteristics. Our results suggest that hedge funds can earn positive excess returns by timing their exposure to emerging market securities.     

Forms of Foreign Investment Liberalization and Risk in Emerging Stock Markets

I examine the effect of different forms of foreign investment liberalization on risk in emerging equity markets, including international cross-listings and closed-end country funds, and in the domestic equity market as foreign investment restrictions are eliminated. I find that in Latin American markets volatility declines significantly with different forms of foreign investment liberalization, and in Asian markets volatility does not increase significantly. Volatility is driven by domestic factors in South America, but the transmission of volatility from the United States to Mexico increases after liberalization. The market risk exposure increases in Argentina after liberalization, in Chile with an index of American Depositary Receipts, and in Thailand with greater foreign ownership, reducing the diversification benefits of these markets.     

Life Settlement Funds: Current Valuation Practices and Areas for Improvement

We analyze the prevailing valuation practices in the life settlement industry based on a sample of 11 funds that cover a large portion of the current market. The most striking result is that a majority of asset managers seem to substantially overvalue their portfolios relative to the prices of comparable transactions that have recently been closed. Drawing on market‐consistent estimates with regard to medical underwriting, it is possible to trace back the observed discrepancies to inadequately low model inputs for life expectancies and discount rates. The main consequences are a dissimilar treatment of investor groups in open‐end funds structures as well as an unduly high compensation for managers and third parties. To address this predicament, we suggest defining life settlements as level 2 assets in the fair value hierarchy of IFRS 13, improving transparency and disclosure requirements, and developing new incentive‐compatible fee schedules.     

The Performance of Actively Managed International Mutual Funds

International mutual funds allow individual investors to diversify abroad at a reasonable cost. This paper tests whether international funds that actively engage in country and security selection outperform passive global benchmarks. We apply a mean-variance efficiency test that incorporates the practical prohibition against short sales of open-end mutual funds. Our tests reject the efficiency of the world equity market portfolio over the sample period, and our funds as a group outperform the inefficient world index. However, we find no evidence of security selectivity ability using a 12-country benchmark. We do find that active international funds provide global diversification benefits. Tests using the Positive Period Weight (PPW) measure of Grinblatt and Titman (1989), which is robust to nonlinearity in fund and benchmark returns, yield similar results.     

The demand for home mortgage assets by savings and loan associations

The purpose of this article is to analyze empirically the factors that enabled S&Ls to respond, concerning their demand for home mortgage assets, to the record high interest rates, inverted yield curves, and new competition for deposits by money market mutual funds. These factors include changing regulatory accounting procedures, increased participation in the secondary mortgage market, and increased asset diversification allowed for by Garn-St. Germain. The empirical results are based on a model of the demand for home mortgage assets specified in terms of an optimal marginal portfolio adjustment model. The results show that changing regulatory procedures and the subsequent impact on secondary mortgage markets had the most impact. The increased lending power granted by Garn-St. Germain had little effect on the demand for home mortgage assets by S&Ls.     

The performance of U.K. investment trusts as internationally diversified portfolios over the period 1968 to 1977

This paper considered the share price performance of a sample of U.K. closed end funds as internationally diversified portfolios over the ten year period 1968 to 1977. Using a performance criterion which does not place restrictions on the form of the distribution functions being compared (i.e., second degree stochastic dominance criterion), U.K. funds are compared to the domestic (U.K.) market index as well as against artificially constructed benchmark portfolios which reflect the historical spread of foreign asset holdings of the funds being examined. The question addressed is whether U.K. investors could have out performed internationally diversified U.K. closed end funds by investing directly into foreign capital markets. The performance results, in sterling terms, indicate that U.K. international funds, were clearly inferior to their assigned benchmark portfolio, with the latter mirroring the historical geographical asset spread of the particular fund being examined.     

Equity fund ownership and the cross-regional diversification of household risk

We explore the link between portfolio home bias and consumption risk sharing among Italian regions using household-level information on consumption, income and portfolio holdings. Since equity funds are typically diversified at the national or international level, we use data on equity fund ownership to proxy for regional home bias. Cross-regional patterns of equity fund ownership are qualitatively consistent with simple portfolio theory: regions with more asymmetric business cycles are more diversified because they have higher fund participation rates (the extensive margin of diversification) and higher average holdings of equity funds (diversification’s intensive margin). Also, fund holdings increase with the exposure of non-tradable income components (such as labor or entrepreneurial income) to regional shocks. Finally, interregional consumption risk sharing increases with fund holdings and this effect seems strongest when participation is widespread. Increased equity market participation could substantially improve interregional risk sharing.     

Market segmentation and international diversification across country and industry portfolios

We conjecture that partially segmented stock indexes that are characterized by low correlation with the world market are mainly priced by local factors and should produce abnormal returns relative to a global asset-pricing model. This implies a negative relation between correlation and future index returns in the presence of segmented indexes. Empirical evidence confirms such a relationship for the sample of industry indexes, suggesting a heterogeneous segmentation. However, we do not observe a similar pattern for country indexes. In addition, the international diversification potential of industries does not vanish during volatile periods. The hypothesis that the negative relationship should be stronger for the more segmented subsamples that are characterized by small market size and emerging country origin is verified for the industry sample. Thus, cross-industry diversification is superior to mere cross-country diversification.