Investing (Investment Management)

Value investing is a common investment strategy, but like all other strategies it has suffered during certain periods, such as the tech rally in the late nineties. This paper examines the Value cycle globally, as well as specifically for Asia Pacific, and considers the impact of possible drivers, including those involving the overall stock market and macroeconomic factors. It was found that the Value cycle was closely linked with the level of risk aversion and, among macroeconomic variables, was most associated with the interest rate cycle.

Publication: MSCI Research Insight
Authors: OWYONG David

Some investors argue that the risk of a market capitalization weighted benchmark is not limited to volatility, but also includes other dimensions, such as high concentration, and excess volatility due to pricing inefficiency. Removing the influence of prices from index weighting schemes could address the issues associated with capitalization weighted benchmarks. Historically, equal weighting has been one such approach.
The MSCI Equal Weighted Indices offer an alternative to market capitalization weighted indices. In the MSCI Equal Weighted Indices, each security is weighted equally at the quarterly index rebalancing.  Weights may fluctuate between rebalancings based on the performance of each security. This alternative weighting methodology removes the influence of prices from the market capitalization weighting scheme at each index rebalancing. Equal weighted portfolios may provide a potential way for earning the small cap premium and avoiding the “bubble traps” or pricing inefficiencies in security prices.

Publication: Update on MSCI Equal Weighted Indices
Authors: MSCI Applied Research

The US equity markets showed their strongest gains for any September on record in the 40-year history of the MSCI USA Index. Here, we highlight a few main observations through the lens of the Barra US Equity Model:
 
• The Growth story was really a Technology story
• The Small Cap story was partially a real small cap effect, but in fact had an important Volatility story behind it (i.e., small caps benefited from being high beta and high volatility)
• Certain sectors, like Health Care and Financial, benefited indexes across the board

Publication: MSCI Research Bulletin
Authors: MSCI Applied Research

The recent financial crisis led many institutional investors to review their asset allocation policies and explore alternative approaches to implementation. MSCI recently held discussions around the world with major pension plans, asset managers, and investment consultants to understand different approaches to implementing equity allocation. Following these consultations, we provide a framework for the implementation of global equity allocation. Our research suggest that global equity mandates, together with dedicated emerging market mandates and small cap mandates, may be emerging as the "new classic" structure for implementing equity allocation.

Publication: MSCI Research Insight
Authors: Fachinotti Giacomo, KANG Xiaowei, NIELSEN Frank

This paper presents a framework for conducting effective stress tests and incorporating insights from stress tests in portfolio construction. We examine how to determine the scope of the test, how to construct severe, but plausible scenarios, how to transmit the shock to the portfolio and how to incorporate the results of stress tests in portfolio construction. Stress testing can be a useful complement to risk model outputs, such as volatility, VaR, and expected shortfall. The key advantage of stress tests is that the loss is linked to a specific event, which can be more meaningful to portfolio managers than a summary statistic of a loss distribution. Prior research on stress testing has concentrated on ways to develop realistic and relevant shocks. The framework presented here attempts to expand on this, by illustrating that stress testing is a broader process addressing a wide range of investment problems and is useful in all stages of investment decisions.

Publication: Research Insight
Authors: MELAS Dimitris, RUBAN Oleg

Stock picking often is carried out with stock screens that reduce the set of eligible stocks. Such screens usually are assessed through the level and volatility of the resultant returns, mostly with associated statistics such as information ratio or Sharpe ratio. This evaluation, however, often is insufficient to uncover unintended bets, and this research bulletin suggests complementing this evaluation by conducting Barra performance attribution on the portfolios obtained from such screening strategies. For example, performance attribution indicates that the book-to-price screen performed relatively poorly in Australia because of an unintended tilt toward low-momentum stocks. In Japan, performance attribution shows that the superior performance of book-to-price over dividend yield as a selection screen from 2009 onward was largely due to non-value tilts.

Publication: MSCI Research Bulletin
Authors: MSCI Barra Applied Research

The oil spill in the Gulf of Mexico has turned into a catastrophic event with major environmental and financial implications. Has this stock specific event had an impact on the wider market? What are the implications for institutional portfolios? What are the long-term investment repercussions from this crisis? This research bulletin discusses these important questions facing institutional investors in the aftermath of the BP oil spill crisis.

Publication: MSCI Barra Research Insight
Authors: KANG Xiaowei, MELAS Dimitris, MSCI Barra Applied Research

The analysis of a possible positive relationship between economic growth and stock market returns is interesting both theoretically and practically. Investors often wonder if they should assign higher weight to countries with higher economic performance, hoping that economic growth will eventually show up in equity returns. Although this relationship seems quite intuitive, historically long-run stock price growth has fallen short of GDP growth in many countries. In this bulletin, we use long-term equity data to analyze the steps leading from GDP to stock prices, and point out several factors that could explain why GDP growth is diluted before it can reach shareholders.

Publication: MSCI Barra Research Bulletin
Authors: MSCI Barra Applied Research , NAGY Zoltan

This Research Bulletin considers Momentum in Asia Pacific stock markets.  We find that Momentum has performed better in some markets than others, and its effectiveness varies across time.  We use the new Barra Asia Pacific Equity Model to capture these variations across markets and over time.  In addition, we test a Momentum timing strategy based on hedging exposure to Momentum during market crashes.  The filter we apply, which is based on those months in which the Momentum factor was negative and statistically important, mitigates drawdowns from Momentum significantly at the regional level.

Publication: MSCI Barra Research Bulletin
Authors: MSCI Barra Applied Research , OWYONG David

High fiscal deficits, a sharp rise in the issuance of sovereign debt from major developed economies, rising inflation expectations, and possible changes in central bank rates could cause the yield curves from around the world to change significantly. This poses challenges for fixed income professionals who need to address possible non-parallel changes to the term structure. This paper illustrates the capabilities of Shift-Twist-Butterfly (STB) factor models to help address these challenges. We provide a longer-term perspective on term structure changes in the Euro zone, US and Japan. Through four portfolio case studies, we show that the use of risk measures, such as duration, convexity or key rate durations, has limitations. These can be overcome by the complementary use of advanced fixed income risk models based on STB interest rate risk factors.

Publication: MSCI Barra Research Insight
Authors: ANAND Iyer, VANNEREM Philippe

This paper examines the holdings data of various active funds in China to analyze their risk and style characteristics over the last five years. We show that fund managers were quick to increase their equity exposure at the beginning of the bull market, and they started to cut their equity exposure before the 2007-2008 bear market arrived. In terms of style, we find that funds had tilts toward momentum and small caps, but away from value.

Publication: MSCI Barra Research Insight
Authors: OWYONG David

We analyze components of long run returns of international equity markets using historical data spanning the 1975-2009 period. The analysis shows that after inflation, dividend income was the most important part of equity returns for the majority of markets. Growth in real book value had a low, but steady contribution to performance. Changes in valuation tended to smooth out in the long run, but had important implications to equity investing in the short run. We also show how expectations of future excess returns – as derived from the price to book ratio –  have evolved over time and converged among different regions.

Publication: MSCI Barra Research Bulletin
Authors: NAGY Zoltan

The Liquidity style factor in the new and enhanced Barra Europe Equity Model (EUE3) helps to assess the systematic risk associated with infrequent trading. In this Research Bulletin we look at the risk and return to the EUE3 Liquidity factor in different market environments, the link between stock liquidity and stock size and sector, and the relationship between the significance of the Liquidity factor and market performance. This factor's return varied with the market cycle during the rally of 1995-2000 and the correction of 2000-2003. In the more recent cycle, there was less dispersion between the rally and the correction. We also find that there are some systematic relationships between a company's liquidity and its size and sector. Finally, we find that the EUE3 Liquidity factor return tends to be statistically significant when the market moves up or down in a meaningful way, which is consistent with our analysis of the Liquidity factor in GEM2.

Publication: MSCI Barra Research Bulletins
Authors: MSCI Barra Applied Research

This Research Insight examines the question of whether currency hedging is a ‘free lunch' of risk reduction and zero expected returns. Using a long history of hedged and unhedged MSCI indices, we find that hedging does not always reduce risk, nor are mean returns zero. Contrary to some prior studies, we find there is no free lunch for the equity investor. Instead, we conclude that the usual, intuitive relationships hold: less risk usually means lower returns, and more risk, higher returns. Our research indicates that whether  hedging pays off depends not only on the base currency, market, and hedging horizon, but also on the investor's goals of risk reduction or return/risk maximization.

Publication: MSCI Barra Research Insights
Authors: CHANG Kelly

We investigate the question of whether currency hedging pays off in the long run using data from the hedged and unhedged versions of the MSCI Global Investable Market Indices.  These data allow us to perform comparisons of unusually large breadth (4 base currencies and 40 markets) and history (1987 to 2008). Our research indicates that the answer depends not only on the base currency, market, and hedging horizon, but also on the investor's goals, e.g. risk reduction or return/risk maximization.

Publication: MSCI Barra Research Bulletins
Authors: MSCI Barra Applied Research

Although the equity markets in October 2008 generated seemingly grim news day after day, how bad were they really? In this Research Bulletin, we examine the returns in historical context using the MSCI Equity Indices.  We find that while October 2008 was, in fact, exceptionally bad, the severity depended on the market, the frequency of the returns examined, and the currency over which returns were calculated.

Publication: MSCI Barra Research Bulletins
Authors: MSCI Barra Applied Research

This is the first in a series of Research Bulletins to mark the launch of the new and enhanced Barra Global Equity Model (GEM2). In this piece, it is shown how GEM2 may be used to track the changing importance of country and industry effects in global equity markets. This information is of use to a portfolio manager in determining the relative size of the opportunity set to generate active returns from country allocation or sector rotation. The results indicate that the relative importance of industry versus country varies across regions and over time. For instance, in emerging markets the potential to generate active returns from country allocation is significantly higher than from sector rotation, while the reverse is true in the developed world.

Publication: MSCI Barra Research Bulletins
Authors: MSCI Barra Applied Research

The global credit crunch has led to high levels of equity market volatility. Financial services companies have been particularly affected, with some large financial institutions failing and others seeing their market capitalization shrink rapidly.  The MSCI Global Islamic Indices, however, do not contain constituents from the financial sector unless they meet the requirements in the MSCI Islamic Index Series Methodology.  In this research note we examine the performance and risk characteristics of the MSCI Global Islamic Indices during the recent market turmoil.

Publication: MSCI Barra Research Insights
Authors: MSCI Barra Index Research

In April 2008 MSCI Barra launched the MSCI World Minimum Volatility Index to serve as a transparent and relevant benchmark for managed volatility equity strategies. As the markets have become more volatile over the last year we explore the behavior of the MSCI World Minimum Volatility Index to determine if it still provides lower volatility in comparison to the MSCI World Index.

Publication: MSCI Barra Research Bulletins
Authors: MSCI Barra Index Research

This paper focuses on the historical diversification benefits of an international allocation and highlights MSCI ACWI IMI and the implications of expanded coverage for international investors along two dimensions: risk-return and international diversification. It also discusses advantages of ACWI IMI as a strategic benchmark.  

Publication: MSCI Barra Research Insights
Authors: KUMAR Arun

Publication: Financial Services Research
Authors: BHANSALI Roveen

Minimum-variance and managed volatility equity strategies have recently gained popularity. We developed a global minimum volatility index that can serve as a transparent and relevant benchmark for managed volatility equity strategies.

Publication: MSCI Barra Research Insights
Authors: NIELSEN Frank

The bursting of the credit market bubble last year and the collapse of a major US investment bank last week resulted in a aggressive rate cutting action from 5.25% to 2.25% during the last six months, similar to the bursting of the equity market bubble in 2000 and the terrorist attacks in 2001 which prompted the Fed to cut interest rates aggressively from 6.50% to 1.75% during 2001. In this note, we examine Barra USE3S (Short term US equity risk model) factor returns' performance, volatility and correlations and identify similarities and differences across the two recent rate cutting phases.

Publication: MSCI Barra Research Bulletins
Authors: MSCI Barra Applied Research

Publication: MSCI Barra Research Bulletins
Authors: MSCI Barra Applied Research

Publication: MSCI Barra Newsletter
Authors: MELAS Dimitris, SURYANARAYANAN Raghu

Explores the benefits of allocating to small caps for Japanese investors. Small caps are increasingly attracting interest in Japan, with the GPIF recently announcing their intent to start allocating to this group of stocks.

Publication: MSCI Barra Research Bulletins
Authors: MSCI Barra Applied Research

Publication: MSCI Barra Research Bulletins
Authors: MSCI Barra Applied Research

Over the long run in the US, value stocks have outperformed growth stocks, a premium that has averaged roughly 200 basis points annually over the last four decades. Since May of this year, growth stocks have exhibited strength over value stocks, as evidenced by the MSCI USA Value and Growth Indices. In fact, the growth premium has averaged 14 percentage points annualized over the last four months—June, July, August, and September. In this article, we put this recent development in historical context and briefly discuss its differences from past periods and its possible drivers.

Publication: MSCI Barra Research Bulletins
Authors: MSCI Barra Applied Research

Fundamental betas provide several conceptual advantages to historical betas--they reflect information on a timelier basis and are less likely to confuse noise for information. This paper revisits the advantages of using fundamental beta for hedging systematic risk in the U.S. Fundamental beta appears to be a more consistent measure for hedging market risk, particularly for investors who care about downside risk and tail risk.

Publication: MSCI Barra Research Insights
Authors: BENDER Jennifer

The book analyzes the performance of various asset classes using our Global Capital Markets Index, International Equity Indices, Domestic Equity Indices for the US, Japan, and China, Fixed Income Indices, and Hedge Fund Indices. This year we also have a section covering our latest efforts in the world of benchmarks, namely, the MSCI REIT indices, High Dividend Yield Indices and the GCC (Gulf Cooperation Council) Countries Indices.

Publication: MSCI Barra Yearbook
Authors: MSCI Barra

Using monthly data from 1991 through 2004, we find evidence for dramatic convergence in properties of globally aggregated developed and emerging markets, greatly limiting the diversifying power of passive emerging markets investing. However, although equity returns in an 'average' emerging market follow the rest of the world more closely than a decade ago, emerging markets still constitute a dynamic and heterogeneous investment environment. We re-confirm that, given the importance of country selection, structuring the investment process along industries in a broad emerging markets universe may be premature. At the same time, there is a growing pool of emerging markets, where the importance of industry selection approaches that of country selection. Finally, we show that intra-market commonalities in equity returns offer significant diversification and return opportunities.

Publication: MSCI Barra Research Insights
Authors: NIELSEN Frank, PUCHKOV Anton V

The use of daily factor returns allows Our Long Horizon US Equity Model (USE3L) to respond more quickly to changing market conditions. When risk is highly dynamic, increased responsiveness results in significantly more accurate risk forecasts. We have conducted a number of practical tests to help clients understand the real-world implications and benefits of using USE3L.

Publication: MSCI Barra Newsletter
Authors: SOMERVILLE Sara, THILGES Brad

With the burst of the technology bubble and private equity returns plummeting, it is no surprise that hedge funds have become an important asset class for high net worth individuals and institutional investors alike. Recently, cautious institutions such as CalPERS, a $158 billion pension fund, and General Motors have announced their plans to allocate significant capital into this arena.  Of special interest to many institutions are long-short equity strategies. In this article we will examine three popular construction techniques deployed by long-short equity portfolios: pairs trading, stratification and optimization. We will build portfolios using each of these methods and then evaluate their ability to achieve the following two goals: 1) Maximize alpha by purchasing undervalued securities and shorting overvalued securities. This has a significant advantage over long-only equity strategies by allowing a manager to better exploit overpriced securities. 2) Offer risk diversification by creating a short portfolio that reduces the long portfolio's risk. This feature enables the construction of popular 'market neutral' strategies. To evaluate the tradeoff between risk and returns, we will use the Sharpe ratio, defined as the ratio of expected returns to forecasted risk.

Publication:
Authors: CASHION Daniel, HANDA Rohtas

In the first of this series of two articles, the case was made for market neutral investing. The central arguments included double alpha, flexibility to diversify risk, an increased opportunity set and most importantly, superior information rations. Theoretical evidence, Monte Carlo simulations and empirical results all highlighted opportunities to improve performance through an institutional market neutral strategy. As the previous article suggested, long-short mangers and active, long-only managers share many similarities; their methods of portfolio construction reinforce this point. This article discusses the construction of market neutral portfolios using the new long-short optimization feature in the Aegis Portfolio Manager (tm). We also compare different long-short construction methods to demonstrate the added value of this new feature.

Publication:
Authors: LEJONVARN Jason, LEKANDER Claes

In past issues of Barra's newsletters, we have presented seven quantitative insights into active management. We can summarize these seven insights by observing how they all fit into the process of active management. The Research stage involves the search for superior information. This information must be better than consensus information (Insight 1: Active Management is Forecasting). We can improve our chances for success by investigating many signals (Insight 3: The Fundamental Law of Active Management). At the same time, we need to avoid data mining (Insight 5: Data Mining Is Easy). The goal of this Research stage is a strategy with a high information ratio (Insight 2: Information Ratios Determine Value Added). The Refinement stage takes our research signals and converts them to alphas by controlling for skill, volatility, and expectations (Insight 4: Three-Part Alphas). The Portfolio Construction and Rebalancing stage and the Trading stage implement the strategy. Here the goal is to lose as little of the intrinsic strategy value as possible (Insight 6: Implementation Subtracts Value). The Performance Analysis stage looks at results, identifying (imperfectly) what worked and what didn't work, in part as feedback to Research (Insight 7: It's Hard to Distinguish Skill from Luck). It is useful to note that while we have presented (and derived) these seven insights as 'quantitative,' they apply to all managers: fundamental, quantitative, top-down, bottom-up, equity, bond, and so forth. Finally, let me point out that we have called this series 'Seven Quantitative Insights...' and not 'The Seven Quantitative Insights into Active Management.' This series has omitted some known insights. And, as a researcher, I will always claim that there remain more insights to uncover. Active management combines art and engineering. The art involves finding valuable information about future returns. The engineering involves efficiently capturing that information in superior portfolios. By assuming that it is possible to find such valuable information, we can derive many important insights into the engineering of this process. Over the next several Barra Newsletters, I will outline seven insights which follow from this perspective. Richard Grinold and I discuss these points more comprehensively in our book Active Portfolio Management, and many of these items appear throughout the lore and literature of the profession.

Publication: Barra Research Insights
Authors: KAHN Ronald N.

This article illustrates another application of Barra's Aegis System with the U.K. Equity Trading Model. The U.K. Equity Trading Model uses the latest risk-modeling techniques to help equity traders manage the short-term risk within their books, and is the first of a series of planned enhancements to Barra's risk models and applications to meet and exceed the demands of the trading community.

Publication:
Authors: BISHOPP Michael, MANANI Rakesh

Data mining is easy. To understand why data mining is easy, we must first understand the statistics of coincidence. Let's begin with some non-investment examples. Then we will move on to investment research.

Publication:
Authors: KAHN Ronald N.

In other articles we have drawn attention to the importance of controlling transaction costs. Electronic Crossing Networks (ECNs), such as the POSIT system2, represent one approach to this problem. Participants in an ECN submit lists of orders they wish to do. The lists are matched up by a computer and matched orders are executed at the midpoint of the bid-ask spread. The system may support additional control by participants over the matching process, for instance the ability to specify minimum fill sizes. However, in this article we will focus on the bare bones of the matching process.

Publication:
Authors: LATHAM Geoff A., TORRE Nicolo

This is the third part of our continuing series on the Market Impact Model.(1) In the first two parts we defined the problem that the model addresses and applied economic reasoning to establish the framework of the solution. Now we shall turn to empirical data analysis to provide the details of the solution. To organize the discussion, we begin by stating the conclusion. We then begin building to this conclusion. First we treat data upon which our work rests. Next we treat each model factor in turn, surveying the principal findings of data analysis. Finally, we show how the information is assembled into the final forecast of market impact.

Publication:
Authors: TORRE Nicolo

Every promising investment strategy on paper loses value on                           implementation. Insight, especially into the relationship between transaction costs and value added, can help minimize this loss.

Publication:
Authors: KAHN Ronald N.

This paper provides an integrated and practical approach to managing risk and performance of a                                    bank on an enterprise level. The results show how analytics can be used along with a strategic management organization to formulate a coherent framework to deal with some of the challenges of our current banking environment.

Publication: Publication forthcoming
Authors: HO Thomas S.Y., STALDER Marco, STRAUB Bernhard

Insight Four: In the previous issue we learned that information ratios, as the key to active management, depend on both skill and breadth. In this issue we will learn the constituent parts of alphas, the fundamental inputs for active management.

Publication:
Authors: KAHN Ronald N.

Information ratios determine value added.

Publication:
Authors: KAHN Ronald N.

Active management combines art and engineering. The art involves finding valuable information about future returns. The engineering involves efficiently capturing that information in superior portfolios. By assuming that it is possible to find such valuable information, we can derive many important insights into the engineering of this process.  Over the next several Barra Newsletters, seven insights that follow from this perspective will be outlined. Insight One: Active management is forecasting.

Publication:
Authors: KAHN Ronald N.

We use the Performance Attribution program of Barra's U.S. fixed ncome model to identify the sources of return to the Barra All-Government, All-Corporate, and All-MBS indices for the period December 31, 1995 ­ April 15, 1996. In the process, we highlight significant developments in the U.S. fixed income market during the period.

Publication:
Authors: MARTIN Bill

Controlling for both style and volatility reveals the greatest insight to the mutual fund investor. An investor who selects mutual funds in this manner retains control over the style mix of his or her aggregate portfolio, just as the institutional plan sponsor does by blending the custom benchmarks of the managers hired. In both cases any incremental value added by the fund manager drops through to the bottom line of the aggregate portfolio. There is another important similarity between individual and institutional fund selection: in both cases identifying the winners in advance is very hard. Despite the sobering odds, this article will compare four methods of ranking mutual funds.

Publication:
Authors: DOERSCH Todd

Professor Robert Haugen made an astonishing observation in the early 1990s about the U.S. equity market. He stated that the return of a fully invested equity portfolio which weights the stocks to minimize total risk achieves a return that is not lower but higher than the return of the S&P 500 index.1 This portfolio has the lowest possible variance and is therefore called the minimum-variance portfolio.  Investing in a minimum-variance portfolio is an appealing strategy, particularly to conservative institutional investors like pension funds and insurance companies.

Publication:
Authors: KLEEBERG Jochen M.

This article presents approaches first for constructing valuation models for fixed-income securities and second for assessing the risk in portfolios of these assets. The linkages across markets in the form of currencies are also addressed in a manner which facilitates the analysis of risk by separating the local market aspects from those purely attributable to currency fluctuations.

Publication: The Handbook of Fixed Income Securities
Authors: GULRAJANI Deepak, MURPHY Brian P., WON David

Barra, in association with RBC Dominion Securities, Inc. of Canada, released on December 6, 1993 a new Canadian fixed-income index, the DS Barra Canadian Bond Market Index. The new index provides the investment community with a benchmark that isfair, accurate and replicable and represents the investable fixed-income market in Canada. Because the constituents are known, the DS Barra Canadian Bond Market Index and sub-indices will allow portfolio managers to perform analyzes and test strategies more easily and efficiently than ever before.

Publication:
Authors: MARTIN Eric

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Publication: Journal of Portfolio Management
Authors: GRINOLD Richard

There have been a proliferation of fixed-income embedded option models. In this article, the author investigates how to choose the most appropriate model. He also discusses the importance of the choice in inputs and the large difference they make in the functionality of the chosen model.

Publication: Journal of Portfolio Management
Authors: LOCHOFF Roland

Interest-only planned amortization classes (PAC IOs) were touted as low-risk alternatives to top-grade corporate debt and regular Fannie Mae and Freddie Mac mortgages. However, the market for PAC Its, which one totaled $25 billion, has collapsed. The typical PAC IO has fallen 50% since late 1991 and some are even down as much as 90%. These terrible results have occurred during a bond market rally that produced positive returns of 20% on treasuries over the same period. In the last two years, the worst possible secnarieos occured for PAC IO holders. Rates fell sharply beginning in late 1991, transforming the PAC IOs from stable PACs to unstable IOs, for which the market had fallen apart. Unfortunately investors, thinking they were getting stable PAC bonds, settled for trivial spreads over regular mortgage-backeds, not understanding the huge risk they were taking. Investors undertook this risk or as little as 25 basis points over a standard Ginnie Mae mortgage. At the same time, some research papers written by Wall Street experts were touting the attractive characteristics of PAC IOs and indicating that the spreads should get even smaller. This episode illustrates the importance of analyzing CMO tranches independently using dynamic prepayment scenarios and a state-of-the-art CMO model. The behavior of a CMO tranche depends on various factors: the underlying collateral, the CMO deal structure, the position of the tranche in the deal, and the principal distribution rules, among others. Seemingly similar tranches can have very different risk-return characteristics. CMOs are complex securities. One should analyze them in a deal context using dynamic prepayment scenarios. Barra's FASTCMO program not only can enter and analyze recently issued CMO deals, it can analyze the effect of various factors that affect the risk-return performance of the tranches of existing deals.

Publication:
Authors: ANUMOLU Srinivas

In the last issue of the Barra Newsletter, we described a model which values and assesses the risk of Canadian Government bonds.(1)  In this article, we will describe specific models developed for the other three sectors--Provincial, Corporate, and Municipal--of the Canadian bond market. These models are then integrated with the Canadian Government bond model to produce a comprehensive Canadian valuation                            and risk model broadly applicable to the Canadian domestic bond market. This article builds upon the Canadian term structure model described in Part I in the previous issue of the Barra Newsletter. Together, these articles provide a complete description of our Canadian bond valuation and risk model. The yield spread models described here provide a logical and accurate description of bond spreads. The models are built upon intuitive factors to provide an integrated and comprehensive framework for analyzing value and risk in the Canadian bond market.

Publication:
Authors: CHUI Benjamin P., GULRAJANI Deepak

The Domini Social Index (DSI) provides a broad market, common stock index for measuring the performance of portfolios with social constraints. The social investment research firm of Kinder, Lydenberg, Domini & Co. (KLD) constructs the DSI by identifying U.S. stocks that pass a multitude of common social screens, including  involvement in such factors as military contracting, alcohol and tobacco, gambling, nuclear power, South African involvement, environmental mismanagement, and poor employee relations. The initial Domini Social Index was created on May 1, 1990 by KLD. We used Barra's PC Performance Analysis package (PAN) to calculate performance on  the DSI index portfolios from May 1, 1990, to September 30, 1992, with the S&P 500 serving as the benchmark.

Publication:
Authors: LUCK Christopher, PILOTTE Nancy

The author tests the efficiency of benchmark portfolios in five equity markets. The test takes a mix of portfolio strategies and calculates the ex post efficient frontier that could have been obtained using combinations of   those strategies. The test points to the inefficiency of four of the five benchmarks. Value-based strategies do well in all the markets and are statistically significant in all markets except Germany.

Publication: Journal of Portfolio Management
Authors: GRINOLD Richard

Barra, in collaboration with Standard and Poor's Corporation, has constructed the S&P/Barra Growth Index and S&P/Barra Value Index to separate the S&P 500 into value stocks and growth stocks. The design of the indexes is an outgrowth of research into investment styles in the U.S. equity market performed in conjunction with 1990 Nobel Laureate William F. Sharpe. The indexes serve as benchmarks for institutional investors who wish to more closely track these two dominant investment styles in the market.

Publication:
Authors: BUCKLEY Oliver

The presence of transaction costs in the utility function and the ability to enter individual commission and market impact costs for each eligible security allow the manager to perform a realistic optimization where the implementation issues do impact the optimal solution along with more theoretical mean-variance efficiency considerations.

Publication:
Authors: VANGELISTI Marco

What is the appropriate passive benchmark or target for the fixed income portion of a pension fund? Long bonds don't seem to reward investors for the additional 'horizon' risk. Long bonds are an appropriate investment only when rates are expected to decline. The appropriate neutral position is to invest in intermediates; thus, the target portfolio or long-term benchmark should be intermediate, not long, bonds.

Publication:
Authors: BAKER Edward

Floating rate notes, or "floaters," are bonds whose coupon is tied to a prevailing interest rate, such as the six-month T-bill rate. Since their coupon is not fixed, they offer investors a  unique tool to control risk and return  In particular, floaters offer a long stream of cash flows with low duration (term structure risk exposure). Many, such as mortgage-backed floaters, offer a higher yield than a comparable short-term security while maintaining high quality. Finally, floaters allow an investor to take on active spread bets while taking on little or no term structure risk. To benefit from these attributes, an investor must understand the nature of floaters from their simple form (the default-free floater) to the more complex (floaters with a corporate spread).

Publication:
Authors: MITROFF Andrea

Many of our clients have begun to use factor tilts as an active investment strategy. This relatively low­risk strategy emphasizes or de­emphasizes those factors which the manager thinks will outperform or  underperform the market.. We hope the following discussion will help readers formulate tilt strategies, and will help current tilt managers more explicitly consider some potential pitfalls.

Publication:
Authors: LUCK Christopher

Have companies controlled by the Bronfman family performed differently from the rest of the Canadian market?  A request by a Barra client prompted us to investigate this question.

Publication:
Authors: MULLER Peter

Market-neutral hedge funds are becoming increasingly popular in the institutional investment world; managers apparently find the advantages more compelling than the disadvantages. The major advantage to these funds is their flexibility, which can magnify the manager's alpha. How do these hedge funds work?

Publication:
Authors: GOTTIPALLI Praveen

How difficult is it to track a market index with a limited number of assets? The question is an important one, since most of the world's smaller equity markets are narrow and are dominated by a few large companies. This type of structure has definite consequences in predicting the risk of portfolios holding these countries' assets. New Zealand is a case in point. Its market is quite narrow; its largest company, Fletcher Challenge, represents more than 23% of the Barclays Index, and its five largest companies make up 64% of the weight of the forty-stock capitalization-weighted index. How well can we track the Barclays Index - New Zealand's most quoted? The compromise between a portfolio which reduces tracking error and one which is easy to implement is an individual decision to be made by each investor. The investor may find the Global Equity Model useful in informing this decision, whether in New Zealand's equity market or in other small markets.

Publication:
Authors: HARRISON Andrew

A proponent of tactical asset allocation claims that a good tactical asset allocator is more valuable than an equally good equity or bond manager. After all, the tactical asset allocator  influences more assets. This assertion raises two interesting questions. What do we mean when we say an allocator or a manager is "good?" And how is value added related to assets under management? (Or, if we want to reverse causality, "How should assets under management be related to the ability to add value?")

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Authors: GRINOLD Richard

Predictions of economic disaster for the San Francisco Bay Area followed close upon the heels of last year's Loma Prieta earthquake. Businesses would be hobbled by transportation bottlenecks, loss of plant and equipment, and a stunned labor force. Sensational media coverage of the destruction in Santa Cruz, the fire in San Francisco, and the demolished Cypress Street freeway structure in Oakland only reinforced this                            bleak prognosis. Many expected Wall Street to rush out even as the Red Cross, Dan Quayle and Dan Rather rushed in. Barra's analysis shows otherwise. The stocks of locally based firms actually outperformed a comparable national index in the last year. The relatively strong performance of the Bay Area portfolio is a pleasant suprise. Those looking for evidence of event risk in the equity market won't find much here. Investors who resisted a knee-jerk reaction to dump Bay Area stocks after the earthquake were rewarded for their fortitude.

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Authors: FREEMAN John

Recently we've heard a lot about the U.S. and Japanese auto industries from a political                            point of view. This article will use Barra's WorldGraph program to look at these industries from an investor's perspective. As we will see, neither the Japanese nor the U.S. auto industries have been very good to their investors.

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Authors: FEINSTEIN Allan

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Authors: Source: Barra Newsletter

Is there any significant difference between trading after the close and trading intraday? The question is important for managers and brokers because a significant body of evidence indicates that the closing price has unusual characteristics.

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Authors: Source: Barra Newsletter

In Parts 1 and 2 of this series [See the May 1989 (#117) and June 1989 (#118) Barra U.S. Newsletters] we talked about active management from the perspective of a highly quantitative manager and from the viewpoint of a more qualitative manager. Both managers concentrated on asset selection. That is, they each had a method of selecting assets that they thought would experience extraordinary return. Any common factor positions that resulted were purely incidental to their processes. We used the Optimizer to reduce these common factor positions, while maintaining a tilt toward assets they preferred. This month, we will consider a manager with a factor tilt strategy. This manager has been hired to manage U.S. equity funds which outperform the S&P500. The manager has looked at the history of the Barra factors and has decided to tilt the portfolio toward risk indexes that have performed well in the past.

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Authors: FEINSTEIN Allan

This is the first in a series of articles devoted to active management. Several examples illustrate practical aspects of Barra's view of active management. We also describe the theoretical framework and the translation of theory into practice. This paper focuses on a highly quantitative style of active management and talks about the concept of portfolio utility.

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Authors: FEINSTEIN Allan

The ingredients needed for successful active management are luck, skill, and humility. Luck and skill are obviously valuable. Humility, as in knowing what you don't know, is required when luck fails. This article shows how humility can work to your advantage. Humility places the burden of proof on the active decision. It forces the manager first to decide what portfolio to hold when he or she has no insights, and then to justify deviations from that original portfolio due to his or her particular insights. Deviations need to be justified with expectations of compensating return, and a method of portfolio construction should be used to make sure that the highest level of expected return is attained per unit of risk.

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Authors: Source: Barra Newsletter

Currency proxy baskets are easily constructed using WMMOPS. These proxies make various hedging strategies manageable and less expensive to implement. All of the various hedging approaches need periodic rebalancing due to local market movements that increase or decrease the amount of the hedge and change the hedge basket composition.

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Authors: Source: Barra Newsletter

In this article, we review the steps to build and maintain an index fund using Barra's index fund analytics.

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Authors: Source: Barra Newsletter

Barra's annual Fixed Income Seminar took place in October 1987, one week before the infamous stock market crash of October 19. At that time we noted an extremely rare event that had already occurred in the year's financial markets. For the first time in recent history, fixed income and equity returns were not only moving in different directions, but were correlated at an unprecedented - .44.(1) Historically, of course, changes in interest rates have had parallel, driving effects on both the bond and stock markets. Prompted in part by the surprising events of 1987, we decided to take a closer look not only at the links between the stock and bond markets as a whole, but also at connections between common factors in these markets.

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Authors: Source: Barra Newsletter

We continue our discussion of index fund management, covering the relationship between transaction costs, odd lots, cash contributions, and portfolio rebalancing.

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Authors: Source: Barra Newsletter

Two previous Newsletter articles summarized sessions of our October, 1987, Fixed Income Seminar. One focused on Barra's Japanese Bond Model, and the other highlighted our improved methods of valuing call options. This article continues the series with a discussion of securitization.

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Authors: Source: Barra Newsletter