Financial Advice and Individual Investor Portfolio Performance
Marc Kramer (University of Groningen) | December 2011
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.
Diversifying Risk Parity
Harald Lohre (Deka Investment GmbH), et al. | December 2011
Striving for maximum diversification we follow Meucci (2009) in measuring and managing a multi-asset class portfolio. Under this paradigm the maximum diversification portfolio is equivalent to a risk parity strategy with respect to the uncorrelated risk sources embedded in the underlying portfolio assets. Our paper characterizes the mechanics and properties of this diversified risk parity strategy. Moreover, we explore the risk and diversification characteristics of traditional risk-based asset allocation techniques like 1/N, minimum-variance, risk parity, or the most-diversified portfolio and demonstrate the diversified risk parity strategy to be quite meaningful when benchmarked against these alternatives.
The Puzzling Countercyclicality of the Value Premium: Empirics and a Theory
Maurizio Montone (University of Cassino) | December 2011
A portfolio made up of a long position in value stocks and a short position in growth stocks yields countercyclical returns. Despite this insurance property, however, unconditional expected returns on value stocks are higher than those on growth stocks. Since these findings are not accounted for by systematic risk, they are at odds with standard finance models and constitute what I call the value premium puzzle. Drawing from Thaler’s (1999) mental accounting theory, I propose a behavioral intertemporal asset pricing model that accounts for the puzzle. The model is also consistent with other well-known empirical phenomena such as imperfect portfolio diversification, momentum trading and participation in lotteries and bets. Overall, the results suggest a new interpretation of the book-to-market ratio as a risk-factor.
Minimum Variance, Maximum Diversification, and Risk Parity: An Analytic Perspective
Roger Clarke (Analytic Investors), et al. | December 2011.
Analytic solutions to Minimum Variance, Maximum Diversification, and Risk Parity portfolios provide helpful intuition about their properties and construction. Individual asset weights depend on systematic and idiosyncratic risk in all three risk-based portfolios, but systematic risk eliminates many investable assets in long-only constrained Minimum Variance and Maximum Diversification portfolios. On the other hand, all investable assets are included in Risk Parity portfolios, and idiosyncratic risk has little impact on the magnitude of the weights. The algebraic forms for optimal asset weights derived in this paper provide generalizable perspectives on portfolio risk-based construction, in contrast to empirical simulations that employ a specific set of historical returns, proprietary risk models, and multiple constraints.
Demystifying Equity Risk-Based Strategies: A Simple Alpha Plus Beta Description
Raul Leote de Carvalho (BNP Paribas), et al. | September 2011
We considered five risk-based strategies: equally-weighted, equal-risk budget, equal-risk contribution, minimum variance and maximum diversification. All five can be well described by exposure to the market-cap index and to four simple factors: low-beta, small-cap, low-residual volatility and value. This is, in our view, a major contribution to the understanding of such strategies and provides a simple framework to compare them. All except equally-weighted are defensive with lower volatility than the market-cap index. Equally-weighted is exposed to small-cap stocks. Equal-risk budget and equal-risk contribution are exposed to small-cap and to low-beta stocks. These three have a high correlation of excess returns and their portfolio largely overlap. They invest in all stocks available and have both a low turnover and low tracking error relative to market-cap index. Minimum variance and maximum diversification are essentially exposed to low-beta stocks. They are the most defensive, invest in much the same stocks and have high tracking error and turnover.