The following is derived from Editor Snapshot podcast summary of the latest issue of the CFA Institute Journal of Financial Analysts. Institutional subscribers and logged in CFA Institute members have full access to all articles.
What’s in the CFA Institute Journal of Financial Analysts Third quarter 2021 issue?
Contributions explore Volmaggedon, American Depositary Receipts (ADR), soft commissions, carbon emissions, the end of the hedge fund era, and the predictability of bonds.
But first, Andrew Lo help celebrate the Log75 first years with “The red financial system in teeth and claws: 75 years of co-evolving markets and technology.” Lo is well known for his “Adaptive Markets Hypothesis,” and here he reflects on the adaptation or evolution of financial practice with that of technology. It defines eight eras of financial evolution from 1945 to the present, mapping each against the technological development of the time as well as financial and regulatory milestones. From Bretton Woods to bitcoin, it traces how we got here and explores what’s next.
“Volmageddon” is the nickname for the February 5, 2018 short volatility strategies market crash that led to the demise of some inverse VIX exchange-traded products in the United States and continues to serve as lessons for us today. In “Volmageddon and the failure of short volatility products,“Patrick Augustin, Ing-Haw Chen and Ludovic Van den Bergen guide readers through the stages of the negative feedback loop that created Volmageddon and demonstrate the pitfalls of hedging and leverage rebalancing when markets are concentrated and volatility increases.
For those looking to go further, “Leveraged and Reverse Exchange Traded Products: Blessing or Curse,” by Colby J. Pessina and Robert E. Whaley, of this year’s first quarter edition Logmakes a good reading companion.
ADRs allow US investors to participate in foreign stocks in US markets and allow foreign companies to achieve a kind of cross-listing that potentially lowers their cost of capital. For companies in markets such as China where IPO legislation can be tricky, ADRs can be an attractive alternative. But they are not without controversy. In “Chinese and global ADRs,The authors review the ADR performance of companies around the world from the 1950s to the present day and provide an excellent introduction to the scope, history and diversity of ADR. Investors have enjoyed significant performance and diversification advantages in this market, particularly with regard to Chinese companies. But researchers are concerned that the “Foreign Company Liability Act,” among other laws, could limit the future of Chinese ADRs in particular.
Speaking of legislation, it has been more than three years since MiFID II became applicable in Europe and some re– the legislation on reunification will come into force next year. Soft commissions, or the bundling of enforcement and research, have been the subject of debate and legislation for years. In “To group or not to group? A review of flexible commissions and research unbundling,“Researchers are systematically reviewing all the literature so far to inform the way forward. They report a consensus in the literature so far on agency conflicts and the costs of clustering. Post-MiFID research legislation in Europe collectively indicates higher research quality but reduced research coverage. But it also highlights the difficulty of cross-border brokering, presents conflicting results on the effect of unbundling on small businesses, and speculations about mixed models in the future. It provides an excellent cheat sheet on all the work done on soft commissions so far: consensus and conflict are beautifully summarized with recommendations on the way forward.
After unbundling, let’s decarbonize! In “Decarbonize everythingauthors from Harvard and State Street analyze how using different measures of climate risk leads to different portfolio carbon outcomes and risk-adjusted returns. They explain the origin, strengths and weaknesses of the different types of carbon metrics: scope 1, 2 and 3 emissions, operational emissions, total value chain, analysts’ notes, etc. Researchers attempt to construct a “decarbonization” factor by designing long-short portfolios that combine various metrics. Their results are illuminating, particularly across sectors or industries and especially for investors and managers looking to manage climate risk in portfolio construction.
The issue ends with bad news on hedge funds and good news on bonds. In “Hedge fund performance: the end of an era?” Nicolas PB Bollen, Juha Joenväärä and Mikko Kauppilad demonstrate that hedge fund performance really deteriorated after 2008. Overall performance declined across all funds. Moreover, the ability of established models to select hedge funds has not helped investors much. The authors test a number of different theories and conclude that post-2008 reforms and central bank interventions were the likely turning point. Their advice to investors? Scale down hedge fund return expectations from now on.
The good news is that government bonds are predictable and therefore well worth the effort of an active manager. In “Predicting Bond Yields: 70 Years of International EvidenceRobeco contributors Guido Baltussin, Martin Martens and Olaf Penninga look at bonds in the world’s major markets over a much longer time frame than other studies. They demonstrate robust results for highly tradable strategies with full details for replication. They attribute the premium available for active management of bond funds not to market or macroeconomic risks, nor to transaction costs or other investment frictions, but rather to market inefficiency.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, and the opinions expressed do not necessarily reflect the views of the CFA Institute or the author’s employer.
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