Best of 2015: Research Highlights for Busy Practitioners

Each month the editors and editorial board of CFA Digest sift through hundreds of articles from periodicals and academic journals to help readers stay abreast of relevant practitioner-oriented research in the field of finance and investments. Based on their usefulness for holders of the CFA designation, just a few articles each month are summarized in CFA Digest, which was first published in 1971.

So which were most popular with readers this year?

Insight into Asset Pricing Models

With ultra-low interest rates persisting, investment professionals are clearly seeking ideas on how best to value equity and bond market assets. Several of this year’s top CFA Digest downloads are condensed summaries of papers covering asset-pricing models, valuation, and the cost of capital. A summary of “The Capital Asset Pricing Model: Theory and Evidence,” a landmark 2004 paper by Eugene Fama and Kenneth French, achieved renewed popularity this year.

Another golden oldie to return to prominence was “The Market Value of Debt, Market versus Book Value of Debt, and Returns to Assets.” This CFA Digest summary condenses an important older paper by Richard Sweeney, Arthur Warga, and Drew Winters. One of the most popular new CFA Digest summaries of 2015 was of a Journal of Financial Economics paper, “A Five-Factor Asset Pricing Model,” also by Eugene Fama and Kenneth French. Yet another valuation modelling paper to make it into the top 10 was a summary of a landmark 2005 study, “The P/B-ROE Valuation Model Revisited” by practitioners Jarrod Wilcox, CFA, and Thomas Philips. The price-to-book ratio-return on equity model shows no signs of disappearing from the investor’s toolbox.

Adding Skills

CFA Digest readers are also keen to excel in life skills and lifelong learning. In “How to Keep Learning and Still Have a Life,” Lisa Burrell, writing in the Harvard Business Review, argues that education needs to be both fun and doable or employees will not be motivated to participate. “Mindfulness Can Literally Change Your Brain,” according to another summary of a Harvard Business Review metastudy, looks at mindfulness as an antidote to the many dysfunctional aspects of modern business life. Antidotes are clearly in demand, suggesting, sadly, that dysfunction persists.

Well-Functioning Markets?

Amid challenging markets, investors are understandably questioning critical elements of their investment chains and established strategies. Benjamin McMillan of Van Eck Global, writing in the Journal of Index Investing, asks “When Does Active Management Add Value?” He finds that long-short hedge funds have not backed up claims of outperformance during market instability. In “Do Security Analysts Speak in Two Tongues?” researchers look more closely at positively biased analyst recommendations and examine whether they are strategically or non-strategically biased.

In “Why Do We Abuse, Misuse, and Confuse Standard Deviation?” David Spaulding, CIPM, evaluates shortcomings in a metric commonly used to assess risk by measuring the volatility and dispersion of returns. Finally, and perhaps unsurprisingly, the workings of the volatile Indian stock market have also excited CFA Digest readers’ imaginations. In “How Profitable Is the Indian Stock Market?” researchers test axioms from finance literature that implementing momentum or contrarian strategies should generate higher profits in inefficient non-developed markets that lack liquidity and international arbitrageurs. Please find below the full list of our top 10 freely downloadable CFA Digest articles for your enjoyment.

1. The Capital Asset Pricing Model: Theory and Evidence

The capital asset pricing model (CAPM) provides an appealing explanation of the relationship between risk and asset returns. The authors summarize the theory and review empirical tests of the CAPM and determine that the CAPM fails to fully explain the relationship between risk and returns. They conclude that the empirical failures of the CAPM invalidate most of its applications.

2. The Market Value of Debt, Market versus Book Value of Debt, and Returns to Assets

The use of book value of debt is pervasive in empirical finance, although finance theory is usually couched in terms of market value of debt. The authors measure the market value of debt and assess the measurement errors introduced by the use of book values in capital structure and cost of capital calculations. They conclude that measurement errors in cross-sectional studies are likely to be small, although the errors are more severe in time-series cross-sectional analyses and in those that examine the cost of capital.

3. How to Keep Learning and Still Have a Life

There is an emerging mandate from both peers and companies for employees to sustain their learning activity. Whether it is self-directed or pushed by companies, the studies most be both enjoyable and readily realizable or staff won’t be inclined to perform them.

In school, grades differentiate students from each other, and in the business world, continuing education can do the same. Those who are scouting for new learning opportunities and taking advantage of them will eventually set themselves apart from others.

4. A Five-Factor Asset Pricing Model

The authors introduce a five-factor asset pricing model that outperforms the well-known Fama–French three-factor asset pricing model in explaining stock returns. Surprisingly, when the two additional factors of profitability and investment are added to the original three-factor model, the value factor becomes superfluous. Although the five-factor model is not without its challenges, it is useful in describing the cross-sectional variance of the factors’ expected return.

5. How Profitable Is the Indian Stock Market?

Although the mere size and recent growth of the Indian equity market has attracted much academic research testing the underlying market efficiency, little has been documented on whether investment in Indian stocks is meaningful for investors. The Indian stock market seems to be characterized by significant profitability, but it varies among different sectors in the economy.

6. The P/B-ROE Valuation Model Revisited

The price-to-book ratio–return on equity (P/B–ROE) approach to stock valuation is a two-stage model that was developed in 1984 by Wilcox. In this paper, the authors enhance the model for predicting returns of both individual stocks and market indices. According to the authors, the model offers three distinct advantages over other models.

7. When Does Active Management Add Value?

The hedge fund industry claims that actively managed funds can offer uncorrelated alpha compared with traditional investments. Attempting to gain insight into the value added from actively managed long–short equity hedge funds, the author finds that as a group, they tend to produce negative alpha during periods of market instability — the opposite of what the fund managers tend to claim.

8. Do Security Analysts Speak in Two Tongues?

Previous research suggests that analyst recommendations are positively biased. These recommendations can either be strategically biased or non-strategically biased. Nonstrategic distortions occur when positive recommendations and optimistic forecasts are present. Strategic distortions occur when positive recommendations and less optimistic forecasts are present. The authors find that affiliated analysts have a stronger tendency to distort strategically than non-affiliated analysts.

9. Why Do We Abuse, Misuse, and Confuse Standard Deviation?

Standard deviation is widely relied on to assess risk by measuring the volatility and dispersion of returns. Despite this popularity, the statistic is often misapplied or its shortcomings ignored, resulting in invalid conclusions. Some applications of standard deviation are ambiguous even within the Global Investment Performance Standards (GIPS) framework.

10. Mindfulness Can Literally Change Your Brain

Research at neuroscience laboratories suggests the practices of mindfulness and meditation physically alter how the brain operates. Contextualized into the business world, these discoveries raise questions about whether businesses are functioning optimally without applying aspects of mindfulness to their processes.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.