Individual investors’ information use,subjective expectations,and portfolio risk and return

What information do individual investors use when making their financial decisions and how is it related to their stock market expectations, their confidence in these expectations, and the risk and return of their stock portfolios? I study these questions by combining survey data on the information usage among individual investors in Sweden with detailed registry data on their stock portfolios. I find that investors use filtered financial information (e.g. information packaged by a professional intermediary) more frequently than they use unfiltered financial information (e.g. information from annual reports and financial statements). Investors who frequently use filtered financial information are, however, more confident in their stock market expectations and take larger risks in their stock portfolios. Investors that instead use unfiltered financial information take lower portfolio risks and obtain higher portfolio returns. The findings in this paper thus suggest that investors can improve their financial decisions by using more unfiltered financial information rather than filtered financial information when they make their financial decisions.     

Islamic and conventional portfolios optimization under investor sentiment states: Bayesian vs Markowitz portfolio analysis

This paper investigates the portfolio optimization under investor’s sentiment states of Hidden Markov model and over a different time horizon during the period 2004–2016. To compare the efficient portfolios of the Islamic and the conventional stock indexes, we have employed two approaches: the Bayesian and Markowitz mean-variance. Our findings reveal that the Bayesian efficient frontier of Islamic and conventional stock portfolios is affected by the investor’s sentiment state and the time horizon. Our findings also indicate that the investor’s sentiment regimes change the Islamic and the conventional optimal diversified portfolios.Moreover, the results show that the potential diversification benefits seem to be more important when using the Bayesian approach than when applying the Markowitz approach. This finding is valid for the bearish, depressed, bullish and calm states in Islamic stock markets. However, the diversification of potential portfolios is significant only for the bullish and the bubble states in the conventional financial markets.The findings of the study provided additional evidence for investors to exploit googling investor sentiment states to evaluate the portfolio performance and make an optimal portfolio allocation.     

Analysts' Roundtable on Integrating ESG into Investment Decision‐Making

In this third of the three discussions that took place at the SASB 2016 Symposium, practitioners of a broad range of investment approaches—active as well as passive in both equities and fixed‐income—explain how and why they use ESG information when evaluating companies and making their investment decisions. There was general agreement that successful ESG investing depends on integrating ESG factors with the methods and data of traditional “fundamental” financial statement analysis. And in support of this claim, a number of the panelists noted that some of the world's best “business value investors,” including Warren Buffett, have long incorporated environmental, social, and governance considerations into their investment decision‐making. In the analysis of such active fundamental investors, ESG concerns tend to show up as risk factors that can translate into higher costs of capital and lower values. And companies' effectiveness in managing such factors, as ref lected in high ESG scores and rankings, is viewed by many fundamental investors as an indicator of management “quality,” a reliable demonstration of the corporate commitment to investing in the company's future. Moreover, some fixed‐income investors are equally if not more concerned than equity investors about ESG exposures. ESG factors can have pronounced effects on performance by generating “tail risks” that can materialize in both going‐concern and default scenarios. And the rating agencies have long attempted to reflect some of these risks in their analysis, though with mixed success. What is relatively new, however, is the frequency with which fixed income investors are engaging companies on ESG topics. And even large institutional investors with heavily indexed portfolios have become more aggressive in engaging their portfolio companies on ESG issues. Although the traditional ESG filters used by such investors were designed mainly just to screen out tobacco, firearms, and other “sin” shares from equity portfolios, investors' interest in “tilting” their portfolios toward positive sustainability factors, in the form of lowcarbon and gender‐balanced ETFs and other kinds of “smart beta” portfolios, has gained considerable momentum.     

Can exchange traded funds be used to exploit industry and country momentum?

There is overwhelming empirical evidence on the existence of country and industry momentum effects. This line of research suggests that investors who buy country and industry portfolios with relatively high past returns and sell countries and industries with relatively low past returns will earn positive risk-adjusted returns. These studies focus on country and industry indexes that cannot be traded directly by investors. This raises the question of whether country and industry momentum effects really can be exploited by investors or whether they are illusionary in nature because they exist only on non-tradable assets. We analyze the profitability of country and industry momentum strategies using actual price data on exchange traded funds (ETFs). We find that over the sample periods during which these ETFs were traded, an investor would have been able to exploit country and industry momentum strategies with an excess return of about 5 % per annum. These returns cannot be explained by unconditional exposures to the Fama–French factors. The daily average bid-ask spreads on ETFs are substantially below the implied break-even transaction cost levels. Hence, we conclude that investors who are not willing or able to trade individual stocks may use ETFs to benefit from momentum effects in country and industry portfolios.     

Talk and Action: What Individual Investors Say and What They Do

Combining survey responses and trading records of clients of a German retail broker, this paper examines some of the causes for the apparent failure to buy and hold a well-diversified portfolio. The subjective investor attributes gleaned from the survey help explain the variation in actual portfolio and trading choices. Self-reported risk aversion is the single most important determinant of both portfolio diversification and turnover; other things equal, investors who report being more risk tolerant hold less diversified portfolios and trade more aggressively. Less experienced investors similarly tend to churn poorly diversified portfolios. The effect of perceived knowledge on portfolio choice is less clear cut; holding other attributes constant, investors who think themselves knowledgeable about financial securities indeed hold better diversified portfolios, but those who think themselves more knowledgeable than the average investor churn their portfolios more. We thank Carol Bertaut, Anne Dorn, Larry Glosten, Will Goetzmann, Charles Himmelberg, Wei Jiang, Alexander Ljungqvist, Theo Nijman, Paul Sengmüller, Ralph Walkling, Elke Weber, and participants at the 2003 European Finance Association meetings in Glasgow for their comments.     

An Exploratory Study on Nonlinear Causality Among the MILA Markets

According to conventional portfolio theory, an increase in the interconnectedness of international financial markets may reduce the potential for constructing diversified portfolios. This article explores the implications of the creation of the Latin American Integrated Market (MILA)¹ over the dependence structure of its members using correlation and cointegration analysis as well as linear and nonlinear Granger causality tests. The creation of MILA aimed to enhance the integration process that Latin American financial markets “naturally” present while still providing diversification opportunities to investors. The results of our empirical analysis suggest that such objective is being achieved. Evidence of a rise in cross-country linear correlations and their linear causal relationship supports the idea of an increasing financial integration process in the region, while the absence of cointegration and the weakening of the nonlinear causal relationship favors the creation of diversified regional portfolios. These findings provide valuable insights for investment portfolio designers, regulators, and supervisors.     

A Note on the Three–Portfolios Matching Problem

A typical problem arising in financial planning for private investors consists in the fact that the initial investor's portfolio, the one determined by the consulting process of the financial institution and the universe of instruments made available to the investor have to be matched/optimised when determining the relevant portfolio choice. We call this problem the three–portfolios matching problem. Clearly, the resulting portfolio selection should be as close as possible to the optimal asset allocation determined by the consulting process of the financial institution. However, the transition from the investor's initial portfolio to the final one is complicated by the presence of transaction costs and some further more specific constraints. Indeed, usually the portfolios under consideration are structured at different aggregation levels, making portfolios comparison and matching more difficult. Further, several investment restrictions have to be satisfied by the final portfolio choice. Finally, the arising portfolio selection process should be sufficiently transparent in order to incorporate the subjective investor's trade–off between the objectives 'optimal portfolio matching' and 'minimal portfolio transition costs'. In this paper, we solve the three–portfolios matching problem analytically for a simplified setting that illustrates the main features of the arising solutions and numerically for the more general situation.     

Do ETFs provide effective international diversification?

Global investments have been a hot issue for years. Investors can diversify risks and obtain benefits from foreign markets by investing directly in the foreign security market or indirectly in Exchange-Trade Funds (ETFs). Because direct investments are not always feasible, we investigate whether indirect investments can replace direct investments. We create different regional optimal portfolios containing ETFs and ensure optimal asset portfolio allocation. In addition to mean-variance approach, the Sharpe index, we also adopt the Campbell et al. (2001) method to have the efficient frontier under control risks, the Value at Risk. We apply both normal and non-normal distributions for comparisons and find that different assumptions of return distributions affect the results of efficient frontier. The results show that international diversification is a reasonable strategy. In addition, when comparing ETFs and target market index portfolios, ETFs have higher Sharpe measures than target market indices especially in the emerging markets. However, there are no significant performance differences between direct and indirect methods even if we use different performance measures. We also find that the diversification benefits are the same before and after the Subprime crisis. We conclude that it is effective for investors to use indirect methods to create internationally diversified portfolios.     

Do large-cap exchange-traded funds perform better than their small-cap counterparts in extreme market conditions?

This study proposes a new threshold model that differentiates between the size and sign-dependent responses of large- and small-cap exchange-traded funds (ETFs) to changes in extreme market conditions. The asymmetric returns in extreme upsides, extreme downsides, and “in-between” markets are estimated using three sets of betas. Findings support the notion that small-cap ETFs in all seven countries fall more in extreme downturns than they rise in extreme upturns. By contrast, six out of nine large-cap ETFs climb up in upside more than they fall in downswing. Therefore, investors should be cautious when assigning excessive weights to small-cap ETFs in their portfolio.     

Possibility versus feasibility: International portfolio diversification under financial liberalization

Financial liberalization may have double-edged impacts on international portfolio diversification since it increases financial market integration and market correlation simultaneously. Financial market integration enhances the possibility of diversifying portfolios internationally, while financial market correlation reduces the feasibility of such a diversification benefit. Using a dataset of stock market across 35 countries over the period 2001–2021, this paper examines the “possibility versus feasibility” puzzle arising from international portfolio diversification under financial liberalization. The empirical results show that financial liberalization has a positive (negative or no) impact on diversification benefits in its early (medium or developed) stage respectively due to its dual effects. Moreover, market integration positively affects diversification benefits only in the early stage of financial liberalization, while market correlation consistently has a negative impact on diversification benefits. Furthermore, this paper proposes an integration-correlation-oriented (ICO) diversification strategy to address the “possibility versus feasibility” puzzle, enabling international investors to make appropriate decisions on international portfolio diversification under financial liberalization.     

Mean-variance optimization using forward-looking return estimates

Despite its theoretical appeal, Markowitz mean-variance portfolio optimization is plagued by practical issues. It is especially difficult to obtain reliable estimates of a stock’s expected return. Recent research has therefore focused on minimum volatility portfolio optimization, which implicitly assumes that expected returns for all assets are equal. We argue that investors are better off using the implied cost of capital based on analysts’ earnings forecasts as a forward-looking return estimate. Correcting for predictable analyst forecast errors, we demonstrate that mean-variance optimized portfolios based on these estimates outperform on both an absolute and a risk-adjusted basis the minimum volatility portfolio as well as naive benchmarks, such as the value-weighted and equally-weighted market portfolio. The results continue to hold when extending the sample to international markets, using different methods for estimating the forward-looking return, including transaction costs, and using different optimization constraints.

     

Financial Advice and Individual Investor Portfolio Performance

This paper investigates whether financial advisers add value to individual investors’ portfolio decisions by comparing portfolios of advised and self‐directed (execution‐only) Dutch individual investors. The results indicate significant differences in characteristics and portfolios between these investor groups, but no evidence of differences in risk‐adjusted performance. The findings indicate that portfolios of advised investors are better diversified and carry significantly less idiosyncratic risk. In addition, evidence from an analysis of investors who switch to advice taking indicates that these findings (at least in part) reflect the effect of advisory intervention.     

Equity Home‐Bias: A Suboptimal Choice for UK investors?

In spite of the popularity of international portfolio diversification theory, extant empirical literature shows that investors prefer domestic assets and as a result, many studies argue that investors' portfolios are largely suboptimal. This paper examines whether British investors need to diversify their portfolios internationally to gain performance benefits from international markets or can they obtain these benefits by mimicking the portfolios with domestically traded assets. The results confirm that it is possible to mimic the performance of foreign equity with domestic equity. Indeed, the pay‐offs from homemade portfolios outperform those from international portfolios regardless of the periodic variation in the overall performance of the UK market vis‐à‐vis foreign markets. The superiority of homemade portfolio is more prominent in recent years and is enhanced by the increased internationalisation of developed capital markets. Therefore, investors' home bias is not suboptimal.     

Neural network copula portfolio optimization for exchange traded funds

This paper attempts to investigate if adopting accurate forecasts from Neural Network (NN) models can lead to statistical and economically significant benefits in portfolio management decisions. In order to achieve that, three NNs, namely the Multi-Layer Perceptron, Recurrent Neural Network and the Psi Sigma Network (PSN), are applied to the task of forecasting the daily returns of three Exchange Traded Funds (ETFs). The statistical and trading performance of the NNs is benchmarked with the traditional Autoregressive Moving Average models. Next, a novel dynamic asymmetric copula model (NNC) is introduced in order to capture the dependence structure across ETF returns. Based on the above, weekly re-balanced portfolios are obtained and compared using the traditional mean–variance and the mean–CVaR portfolio optimization approach. In terms of the results, PSN outperforms all models in statistical and trading terms. Additionally, the asymmetric skewed t copula statistically outperforms symmetric copulas when it comes to modelling ETF returns dependence. The proposed NNC model leads to significant improvements in the portfolio optimization process, while forecasting covariance accounting for asymmetric dependence between the ETFs also improves the performance of obtained portfolios.     

基于余弦相似度(CS)和最小生成树(MST)的基金市场复杂网络研究

以中国基金市场中123家基金公司持有的投资组合为样本,综合运用余弦相似度(CS)和最小生成树(MST)方法,考量基金市场复杂网络。结果显示：各家基金公司持有股票组合的相似程度比持有债券组合的相似程度更高,表明他们持有的债券组合较之股票组合更加多元化,基金公司持有的股票相对集中于市值大、成长性高的公司。同时,全部资产投资组合、股票投资组合和债券投资组合等三类基金MST网络的节点度均服从幂律分布,表明大多数基金公司以少数强影响力基金公司为中心聚集起来,彼此之间具有较强的业务关联。此种网络结构特征可能导致市场风险向基金聚集团体集中,其抵御系统性风险的能力偏弱,也不利于满足投资者的理财多元化需求。     

Socially responsible investment portfolios: Does the optimization process matter?

This study investigates the impact of the choice of optimization technique when constructing Socially Responsible Investment (SRI) portfolios. Corporate Social Performance (CSP) scores are price sensitive information that is subject to considerable estimation risk. Therefore, uncertainty in the input parameters is greater for SRI portfolios than conventional portfolios, and this affects the selection of the appropriate optimization method. We form SRI portfolios based on six different approaches and compare their performance along the dimensions of risk, risk-return trade-off, diversification and stability. Our results for SRI portfolios contradict those of the conventional portfolio optimization literature. We find that the more “formal” optimization approaches (Black-Litterman, Markowitz and robust estimation) lead to SRI portfolios that are both less risky and have superior risk-return trade-offs than do more simplistic approaches; although they also have more unstable asset allocations and lower diversification. Our conclusions are robust to a series of tests, including the use of different estimation windows and stricter screening criteria.     

The Role of the Investment Horizon in Optimal Portfolio Sequencing (An Intuitive Demonstration in Discrete Time)

This paper examines the role played by the investor's investment horizon in the choice of optimal portfolios. A complete discrete-time, multiperiod, portfolio model is presented with a choice criterion that is consistent with the traditional utility approach but which is more amenable to a multiperiod environment. It is shown that investors should choose progressively less risky single-period portfolios as their investment horizons grow shorter, even if they do not become more risk averse. This result holds both in the presence and in the absence of a riskless asset. The results are consistent with empirical evidence and the financial planning practice of moving investors into progressively less risky portfolios as they grow older.     

Actively managed mutual funds holding passive investments: What do ETF positions tell us about mutual fund ability?

We provide the first in-depth examination of exchange-traded funds (ETFs) within actively managed mutual fund (AMMF) portfolios to better understand why AMMFs make substantial investments in passive ETFs. We examine the association between holding ETF positions and AMMF performance, as well as indirect measures of performance, including market timing, flow management, and cash holdings. We find that over one-third of AMMFs take an ETF position between 2004 and 2015. Our results indicate that AMMFs allocating large portions of their portfolio to ETFs perform worse, by between 0.41% and 1.63% annually using various performance measures. These AMMFs also exhibit worse market timing and hold more cash. In contrast, AMMFs that hold ETFs in small amounts have similar characteristics to non-user AMMFs. Therefore, the act of holding an ETF does not signal inferior ability, however, taking large ETF positions does.     

互联网金融资产的多目标投资组合研究

互联网金融的快速发展和不断创新,正在悄然改变着公众的投资理财行为。本文在分析互联网金融创新下公众流动性偏好、投资行为变化与资产选择的基础上,构建基于CRRA(常数相对风险厌恶)期末财富期望效用最大化和VaR最小化的多目标投资组合模型。同时引入多目标优化的NSGA-Ⅱ遗传算法,并选择实际数据对模型进行求解,得出最优的互联网金融资产组合。研究表明:(1)互联网金融给传统金融业带来冲击的同时,也改变了人们的流动性偏好、投资行为和资产组合选择。(2)互联网金融在一定程度上调和了金融资产“流动性、收益性和安全性”之间的矛盾,并兼顾了“三性”的相对统一。(3)模型求解结果显示,投资者对互联网金融资产的投资组合为低风险类资产60%左右、高风险类资产40%左右。     

Investors’ aspirations and portfolio performance

Based on a large database of individual investors, I analyze the impact of personal financial goals on portfolio performance. I stress the role played by latent investor aspirations as defined in the Behavioral Portfolio Theory framework. I identify two opposite profiles of investors. High-aspirations investors trade more and hold riskier portfolios than the average investor. By contrast, low-aspirations investors are more diversified than the average investor. I find that when controlling for diversification, turnover and usual risk factors, high-aspiration investors underperform their peers, whereas low-aspirations investors outperform them.