Practical analysis for investment professionals
05 December 2017

Best of 2017: Financial Analysts Journal, CFA Digest, and In Practice

What can we learn from downloads of CFA Institute publications in 2017?

Most obviously, investors still struggle to understand the unintended consequences of the monetary policy experimentation of the last decade.

Perhaps more surprisingly, the most popular article of 2017 is about professional ethics, with Vanguard founder Jack Bogle arguing that strong professional ethics must triumph over greed. Hand in hand with this admirable interest is increased curiosity about socially responsible investing (SRI) and broader environmental, social, and governance (ESG) themes.

Of the newer investment techniques, global factor investing — better known as smart beta — makes an appearance as well. (Check out my trilogy of articles curating factor investing resources.) But the lineup displays a healthy skepticism about quantitative approaches, including data mining, value-at-risk (VAR), and exchange-traded fund (ETF) mispricing.

Traditional investment models, predictive approaches, and drivers of investment returns are now under increased scrutiny, especially since equity valuations took flight thanks in part to a few tech stocks.

Elsewhere on the popularity list, readers of CFA Institute publications display an admirable thirst for more exact and rigorous measuring techniques in investment performance, bond yield spreads, equities research, and instrument pricing.

Confusion among practitioners about the real-world usefulness of behavioral finance models turns out to have an empirical basis. But in addition to its intuitive appeal, behavioral finance may have important practical uses in areas as varied as analyst herding, manager selection, household stock market participation, and investor risk tolerance.

Finally, judging by the renewed interest in understanding what constitutes a genuine value-investing technique rather than a “formulaic impostor,” could there be an end in sight for the prolonged bear market afflicting value stocks?

Top CFA Institute Financial Analysts Journal® Articles of 2017

Balancing Professional Values and Business Values 

The issue faced by CFA charterholders and other financial industry participants is not choosing between professional values and business values, John C. Bogle says. Rather, it is balancing that ever-competing pair in a way that places the best interests of consumers and clients above our own corporate and personal interests.

Are Cash Flows Better Stock Return Predictors Than Profits?

Although various income statement–based measures predict the cross-section of stock returns, direct method cash flow measures have even stronger predictive power, according to Stephen Foerster, CFA, John Tsagarelis, CFA, and Grant Wang, CFA.

Inefficiencies in the Pricing of Exchange-Traded Funds

Antti Petajisto demonstrates that the prices of exchange-traded funds (ETFs) can deviate significantly from their net asset values (NAVs), in spite of the arbitrage mechanism that allows authorized participants to create and redeem shares for the underlying portfolios.

The Long-Run Drivers of Stock Returns: Total Payouts and the Real Economy

Philip U. Straehl and Roger G. Ibbotson provide theoretical and empirical evidence over 1871–2014 that total payouts (dividends plus buybacks) are the key drivers of long-run stock market returns.

Global Equity Country Allocation: An Application of Factor Investing

Implementable through exchange-traded funds or index futures, a portfolio based on country indexes with favorable factor exposures significantly outperforms, both economically and statistically, the world market capitalization portfolio, according to Timotheos Angelidis and Nikolaos Tessaromatis

Facts about Formulaic Value Investing

The term “value investing” is increasingly being adopted by quantitative investment strategies that use ratios of common fundamental metrics (e.g., book value, earnings) to market price. U-Wen Kok, CFA, Jason Ribando, CFA, and Richard Sloan argue that these strategies should not be confused with value strategies that use a comprehensive approach in determining the intrinsic value of the underlying securities.

Time to Change Your Investment Model

Feng Gu and Baruch Lev demonstrate empirically that the gains from predicting corporate earnings, or consensus hits and misses — an activity at the core of most investment methodologies — have been shrinking fast over the past 30 years.

Active Share and the Three Pillars of Active Management: Skill, Conviction, and Opportunity

This article relates active share to the fund manager’s individual stock-picking skill, conviction, and opportunity. Martijn Cremers proposes a new formula for active share that emphasizes that a fund’s active share is reduced only through overlapping holdings with its benchmark.

Do Social Responsibility Screens Matter When Assessing Mutual Fund Performance?

Marie Brière, Jonathan Peillex, and Loredana Ureche-Rangau propose a new decomposition of the variability of SR mutual fund returns that isolates the contribution of SR screening, allowing it to be compared with other, traditional sources of performance.

Top CFA Institute Journal Review Summaries of 2017

Five Mysteries Surrounding Low and Negative Interest Rates

Record-low or even negative interest rates in developed markets are a result of monetary stimuli to stabilize output. The authors investigate the consequences of this new policy for the economy, capital markets, and consumers, as well as its role in fighting the recent financial crisis.

Fundamental Analysis and the Cross-Section of Stock Returns: A Data-Mining Approach

Using fundamental signals from financial statements and a bootstrap approach, the authors find that many fundamental signals predict cross-sectional stock returns even after accounting for data mining. Thus, abnormal returns cannot be attributed to random chance and are better explained by mispricing.

Mind the Gap: Inconsistencies between Subjective and Objective Financial Risk Tolerance

Examining a sizable sample of investors at a large Italian bank, the authors explore the effectiveness of two measurements of risk tolerance — namely, an investor’s own assessment of his ability to bear risk and an examination of the composition of the investor’s portfolio. The authors look for inconsistencies between the two metrics and find that inconsistencies are more evident in individuals with certain demographic traits.

Precautionary Savings with Risky Assets: When Cash Is Not Cash

US industrial firms tend to invest significantly in noncash risky financial assets — for example, corporate debt, equity, and mortgage-backed securities. Such risky assets make up 38% of the firms’ financial portfolios or 6% of total book assets. These assets are held mainly by financially unconstrained firms and by poorly governed firms. Nonfinancial firms may thus be operating in a “shadow” asset management industry subject to minimal regulation and disclosure requirements.

The Effects of Firms’ Information Environment on Analysts’ Herding Behavior

Analysts move as a group toward consensus when those with superior information issue early earnings forecasts in a firm’s opaque information environment. The authors study the information environment of firms.

Has Momentum Lost Its Momentum?

A trading strategy of buying winners and selling losers worked well for several decades. Since 1999, the abnormal positive returns that had accrued to such a “momentum” strategy have disappeared. Rather than being driven by a shift in the market dynamic, the change was driven by — among other factors — investors themselves uncovering the abnormality.

It Pays to Set the Menu: Mutual Fund Investment Options in 401(k) Plans

Mutual fund management companies that provide services to sponsors of 401(k) savings plans exhibit favoritism toward their own affiliated funds. Underperforming affiliated funds are less likely to be removed from the menu of available investment options compared with similarly underperforming non-affiliated funds. The investment choices of plan participants tend to suggest that they are unaware of the potential conflicts of interest involved and continue to invest in underperforming investment options.

Picking Winners? Investment Consultants’ Recommendations of Fund Managers

Institutional investors hire investment consultants to recommend fund managers. Studying the recommendations for US actively managed equity funds, the authors find that factors unrelated to past performance tend to weigh more heavily on the recommendations. Institutional investors are likely to follow the recommendations, significantly affecting fund flows. There is no evidence that these recommendations add value

The Role of Corporate Donations in Chinese Political Markets

Corporations often try to influence politicians and acquire political favors, which may serve as a competitive advantage. The authors investigate corporate donations and explore their role in a commencement of social exchanges between firms and local leaders in China.

Prospect Theory and Stock Returns: An Empirical Test

Investors who use prospect theory to evaluate stocks according to their historical return distributions may excessively bid up stocks with high historical mean returns, low volatilities, and positive skewness. The authors find a negative relationship between stocks’ prospect theory values and their future returns in the cross-section.

Corporate Scandals and Household Stock Market Participation

Corporate fraud reduces participation in the stock market, particularly for households in the place where the fraud occurs. Individual households with a high degree of lifetime experience of corporate scandals reduce their equity holdings. Given the critical importance of positive returns on equities for meeting such goals as education and retirement, corporate fraud has a negative effect on households’ financial well-being.

When Cutting Dividends Is Not Bad News: The Case of Optional Stock Dividends

Optional stock dividends (OSDs) are a novel dividend payout mechanism that induces shareholders to voluntarily choose stock over a cash dividend, saving the firm from having to pay valuable cash reserves without this move being perceived as negative news.

Value-at-Risk under Lévy GARCH Models: Evidence from Global Stock Markets

Since the subprime mortgage crisis, the reliability of types of econometric models used in the financial industry has been criticized for failing to capture risk accurately during financial market downturns. The authors test the predictive power of univariate GARCH-type models, originally developed to estimate market volatility, under various error distribution assumptions and make several findings.

Say It Again Sam: The Information Content of Corporate Conference Calls

The information content of conference calls can be explored using a novel metric. The author compares the words in the management presentation session with those in the Q&A session of corporate conference calls. He finds that the more dissimilar the words used by management during the two sessions, the better the information production. He also finds an improvement in information production when analysts are more engaged during the conference call.

The Unintended Consequences of the Zero Lower Bound Policy

In the aftermath of the global financial crisis of 2007–2008, the US Federal Reserve aggressively pushed down short-term interest rates to promote an atmosphere of price stability and an economic environment conducive to sustainable economic growth. The authors discuss the impact of near-zero interest rates on financial institutions.

Heterogeneous Liquidity Effects in Corporate Bond Spreads

Exploring the way liquidity risk affects bond spreads, the authors find that illiquidity contributes to bond spreads nonlinearly. Illiquidity also affects different classes of bonds heterogeneously. Although the liquidity effect varies over time, it is highly correlated with different bonds.

Corporate Social Responsibility and CEO Confidence

Previous studies have suggested that higher levels of corporate social responsibility (CSR), including such characteristics as corporate reputation and integrity, tend to provide hedging benefits for firms when they are confronted by operational issues that affect customers or employees. The authors show that “confident” CEOs are more likely to underestimate the significance and importance of CSR in reducing the financial and reputational impact of such events.

Top In Practice Summaries of 2017 (CFA Institute Members Only)

The Effect of Social Responsibility Screens on Fund Performance

Socially responsible mutual funds have grown rapidly over the past decade and now represent more than US$8 trillion in assets under management (AUM) in the United States. Despite the popularity of these funds, it is not always clear whether and by how much their extra-financial screens contribute to fund performance.

Detecting ETF Mispricing

Many investors implicitly assume that the price of exchange-traded funds (ETFs), vehicles that provide passive exposure to a basket of securities and real-time liquidity, stays extremely close to their net asset value (NAV). But is it really the case?

Value Investing: Do Quant Strategies Measure Up?

Value investing, based on a company’s fundamental intrinsic value, is one of the most popular and enduring styles of investing. But can investing strategies based merely on formulaic ratios, such as book-to-market, deliver the performance investors expect?

Why Global Equity Funds Outperform

Amid widespread analysis of the performance of US equity funds, only a handful of studies have considered the performance of global equity funds.

Why Should We Care about Active Share?

Does active share predict outperformance? Active share is not a measure of a manager’s skill, but, rather, a mathematical measure of the percentage of the holdings in a fund that are different from the holdings of the fund’s benchmark.

Follow the Cash

Cash flow has long been core to traditional value and growth approaches and to many fundamental beta and factor strategies. But are the most common measures of cash flow used by investors actually good predictors of future company asset values and market values?

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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.

About the Author(s)
Mark Harrison, CFA

Mark Harrison, CFA, was director of journal publications at CFA Institute, where he supported a suite of member publications, including the Financial Analysts Journal, In Practice summaries, and CFA Digest. He has more than 12 years of investment experience as a portfolio manager and securities analyst. Harrison is a graduate of the University of Oxford.

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