Calculating Supply Chain Climate Exposure

By |June 28th, 2022|ESG, Research Insights, Basilico and Johnsen, Academic Research Insight|

To manage climate risks, investors need reliable climate exposure metrics. This need is particularly acute for climate risks along the supply chain, where such risks are recognized as important, but difficult to measure. We propose an intuitive metric that quantifies the exposure a company has to customers, or suppliers, who may in turn be exposed to climate risks. We show that such risks are not captured by traditional climate data. For example, a company may seem green on a standalone basis, but may still have meaningful, and potentially material, climate risk exposure if it has customers, or suppliers, whose activities could be impaired by transition or physical climate risks. Our metric is related to scope 3 emissions and may help capture economic activities such as emissions offshoring. However, while scope 3 focuses on products sold to customers and supplies sourced from suppliers, our metric captures the strength of economic linkages and the overall climate exposure of a firm’s customers and suppliers. Importantly, the data necessary to compute our measure is broadly accessible and is arguably of a higher quality than the currently available scope 3 data. As such, our metric’s intuitive definition and transparency may be particularly appealing for investors.

Using Institutional Investor’s Trading Data in Factors

By |June 22nd, 2022|Insider and Smart Money, Research Insights, Factor Investing, Basilico and Johnsen, Academic Research Insight|

The authors investigate how the interaction between entries and exits of informed institutional investors and market anomaly signals affects strategy performance. The long legs of anomalies earn more positive alphas following entries, whereas the short legs earn more negative alphas following exits. The enhanced anomaly-based strategies of buying stocks in the long legs of anomalies with entries and shorting stocks in the short legs with exits outperform the original anomalies, with an increase of 19–54 bps per month in the Fama–French five-factor alpha. The entries and exits of institutional investors capture informed trading and earnings surprises, thereby enhancing the anomalies.

Factors Investing in Cryptocurrency

By |June 13th, 2022|Crypto, Research Insights, Factor Investing, Basilico and Johnsen, Academic Research Insight|

We find that three factors—cryptocurrency market, size, and momentum—capture the cross-sectional expected cryptocurrency returns. We consider a comprehensive list of price- and market-related return predictors in the stock market and construct their cryptocurrency counterparts. Ten cryptocurrency characteristics form successful long-short strategies that generate sizable and statistically significant excess returns, and we show that all of these strategies are accounted for by the cryptocurrency three-factor model. Lastly, we examine potential underlying mechanisms of the cryptocurrency size and momentum effects.

Do Connections Pay Off in the Bitcoin Market?

By |June 6th, 2022|Crypto, Research Insights, Basilico and Johnsen, Academic Research Insight|

This paper identifies the bitcoin investor network and studies the relationship between connections and returns. Using transaction data recorded in the bitcoin blockchain from 2015 to 2020, we reach three conclusions. First, connectedness is not strongly correlated with higher returns in the first four years. However, the correlation becomes strong and significant in 2019 and Second, returns also differ among those connected addresses. By dividing the connected addresses into ten decile groups based on their centrality, we find that the top 20% most connected addresses earn higher returns than their peers during most of our sample period. Third, eigenvector centrality is more related to higher returns than degree centrality for the top 20% most-connected addresses, implying that the quality of connections may matter more than quantity among those highly connected addresses.

Is There a Gender Gap in Kickstarter Campaigns?

By |May 31st, 2022|ESG, Research Insights, Basilico and Johnsen, Academic Research Insight|

This study focuses on the launch phase of the leading reward-based crowdfunding market—Kickstarter. It documents the behavior of male and female entrepreneurs in raising early stage capital. We find that women share as entrepreneurs in the platform (34.7%) does not equal to their share in the overall population, and they are concentrated in stereotyped sectors, both as entrepreneurs and as backers. We also find that women do not set lower funding goals than men, they enjoy higher rates of success than men, even after controlling for project categories and funding goals, and that backers of both genders have a tendency to fund entrepreneurs of their own gender. Our survey of Kickstarter backers finds evidence of taste-based discrimination by male backers.

How Race Influences Asset Allocation Decisions

By |May 23rd, 2022|ESG, Research Insights, Basilico and Johnsen, Academic Research Insight, Machine Learning|

Of the $69.1 trillion global financial assets under management across mutual funds, hedge funds, real estate, and private equity, fewer than 1.3% are managed by women and people of color. Why is this powerful, elite industry so racially homogenous? We conducted an online experiment with actual asset allocators to determine whether there are biases in their evaluations of funds led by people of color, and, if so, how these biases manifest. We asked asset allocators to rate venture capital funds based on their evaluation of a 1-page summary of the fund’s performance history, in which we manipulated the race of the managing partner (White or Black) and the strength of the fund’s credentials (stronger or weaker). Asset allocators favored the White-led, racially homogenous team when credentials were stronger, but the Black-led, racially diverse team when credentials were weaker. Moreover, asset allocators’ judgments of the team’s competence were more strongly correlated with predictions about future performance (e.g., money raised) for racially homogenous teams than for racially diverse teams. Despite the apparent preference for racially diverse teams at weaker performance levels, asset allocators did not express a high likelihood of investing in these teams. These results suggest first that underrepresentation of people of color in the realm of investing is not only a pipeline problem, and second, that funds led by people of color might paradoxically face the most barriers to advancement after they have established themselves as strong performers.

Form 3 and Form 4 Alpha: Focus on What Insiders Don’t Trade

By |May 16th, 2022|Insider and Smart Money, Research Insights, Factor Investing, Basilico and Johnsen, Academic Research Insight|

Some individuals, e.g., those holding multiple directorships, are insiders at multiple firms. When they execute an insider trade at one firm, they may reveal information about the value of all—both the traded insider position and not-traded insider position(s)—the securities held in their “insider portfolio.” We find that insider “not-sold” stocks outperform “not-bought” stocks. Implementable trading strategies that buy not-sold stocks following the disclosure of a sale earn alphas up to 4.8% per year after trading costs. The results suggest that even insider sales that are motivated by liquidity and diversification needs can provide value-relevant information about insider holdings.

Benefits of Having a Female CFO

By |May 9th, 2022|Research Insights, Women in Finance Know Stuff, Basilico and Johnsen, Academic Research Insight, Machine Learning|

We examine gender differences in the language of CFOs who participate in quarterly earnings calls. Female executives are more concise and less optimistic, are clearer, use fewer idioms or clichés, and provide more numbers in their speech. These differences are particularly strong in the more spontaneous Questions and Answers (QA) section of the calls and are reflected in stronger market and analyst reactions. Gender differences seem to be associated with CFO overconfidence.

The Future of Factor Investing

By |May 2nd, 2022|Research Insights, Factor Investing, Basilico and Johnsen, Academic Research Insight|

In this article, the author discusses current structural research and investment trends that are shaping the future of factor investing. Specifically, the author focuses on three emerging trends: the ongoing evolution of traditional factor models and strategies, recent innovation in data sources and modeling techniques, and the potential disruption from integrating factor strategies into the asset allocation process.

Did Covid-19 Change how We Shop?

By |April 25th, 2022|Research Insights, Basilico and Johnsen, Academic Research Insight, Macroeconomics Research|

We study e-commerce across 47 economies and 26 industries during the COVID-19 pandemic using aggregated and anonymized transaction-level data from Mastercard, scaled to represent total consumer spending. The share of online transactions in total consumption increased more in economies with higher pre-pandemic e-commerce shares, exacerbating the digital divide across economies. Overall, the latest data suggest that these spikes in online spending shares are dissipating at the aggregate level, though there is variation across industries. In particular, the share of online spending in professional services and recreation has fallen below its pre-pandemic trend, but we observe a longer-lasting shift to digital in retail and restaurants.

Can Market Maker Capital Constraints Result in Mispricing of ETFs?

By |April 18th, 2022|Research Insights, Basilico and Johnsen, Academic Research Insight, ETF Investing|

Capital constraints of financial intermediaries can affect liquidity provision. We investigate whether these constraints spillover and consequently cause contagion in the degree of market efficiency across assets managed by a common intermediary. Specifically, we provide evidence of strong comovement in pricing gaps between ETFs and their constituents for ETFs served by the same lead market maker (LMM). The effects are stronger for ETFs that are more illiquid and volatile, when the underlying constituents of the ETFs are more costly to arbitrage, and for LMMs with more constrained capital. Using extreme disruptions in debt markets during COVID-19 as an experiment, we show that non-fixed income ETFs serviced by LMMs managing a larger fraction of fixed income ETFs experience greater pricing gaps. Overall, our results indicate that intermediaries’ constraints indeed influence comovements in pricing efficiencies.

Shorting ETFs: A look into the ETF Loan Market

By |April 11th, 2022|Transaction Costs, Research Insights, Basilico and Johnsen, Academic Research Insight, ETF Investing|

We find that exchange-traded fund (ETF) lending fees are significantly higher than stock lending fees. Two institutional features unique to ETFs play significant roles in explaining the high fees. First, regulations restrict investment companies, such as mutual funds and ETFs, from owning ETFs. As these institutions are key lenders, their absence reduces the lendable supply in the ETF loan market. Second, while the create-to-lend (CTL) mechanism alleviates supply constraints when borrowing demand increases, its efficacy is limited by the associated costs and frictions. Our results speak to the limits to arbitrage in the ETF markets.

Gaining an Edge via Textual Analysis of FOMC Meetings

By |April 4th, 2022|Research Insights, Basilico and Johnsen, Academic Research Insight, Machine Learning, Macroeconomics Research|

How investors understand and use central bank communications, aka FEDSPEAK, is oftentimes cryptic and difficult to analyze.  This study attempts to provide some clarity to this issue by applying textual analysis to both high-frequency price and communication data, to focus on episodes whereby stock price movements are identifiable and on investors’ reactions to specific sentences communicated by the Fed.

What Percentage of Women Serve in Senior Investment Roles?

By |March 22nd, 2022|ESG, Research Insights, Women in Finance Know Stuff, Basilico and Johnsen, Academic Research Insight, Other Insights, Corporate Governance|

There is a “Pink” elephant in the room. The paucity of women in the key investment and decisión-making roles in finance is that “pink” elephant. While women are represented at 33%, 37%, and 63% in the law, medical, and accounting professions, respectively (Morningstar 2016), the percentage of female investment decision-makers in investment pales in comparison at less than 10%. And it gets worse if we look at sub-sectors. Take private equity, it’s 6% (Lietz, 2011), hedge funds at 3% (Soloway, 2011), or investment banking documented in this scorecard, at a global median of 0%.

Are Quant Approaches Best for Sustainable (ESG) Investing?

By |March 21st, 2022|ESG, Research Insights, Factor Investing, Basilico and Johnsen, Academic Research Insight|

After 40 years or so, quantitative investing has evolved into a thriving practice.  A major feature of the quantitative approach involves developing underlying numerical models and testing them on a historical (data) record and then forecasting where alpha may be embedded into the prices of a set of stocks.  Whether you agree or disagree with this approach, it is difficult to deny that with the advanced state of data access and computational skill, “quants will win the day in ESG investing”.   Such is the premise of this article and happily, it is accompanied by a compelling argument.

Are Financial Crises Predictable?

By |March 14th, 2022|Crisis Alpha, Research Insights, Factor Investing, Trend Following, Basilico and Johnsen, Academic Research Insight, Managed Futures Research|

Who among us wouldn't want to be the savior that predicts a market crisis and saves our clients from losses in capital -- or even better -- profits from them? A central topic of interest for academics is whether there are more precise tools to predict financial crises. Those who believe so dedicate their efforts to finding early warning indicators.

New Accounting Standards and Factor Investing

By |March 7th, 2022|Research Insights, Factor Investing, Basilico and Johnsen, Academic Research Insight, Value Investing Research, Momentum Investing Research, Size Investing Research|

How well do quantitative investors navigate around the changes to the accounting standards that are endemic to the financial data used in quantitative strategies? The numbers reported on financial statements are wholly governed by regulation and by each firm’s interpretation of those accounting standards.  So how do quants stick to their empirical evidence on old data methods or do they react in terms of the strategy when the change in standards is material?

Does diversification always benefit investors? No.

By |February 22nd, 2022|Empirical Methods, Research Insights, Basilico and Johnsen, Academic Research Insight, Tactical Asset Allocation Research|

This article examines the extent to which these assumptions hold and the extent to which investors should want them to hold.  The authors deliver a clever quote from Mark Twain (or maybe it was Robert Frost) that nails the issue in simple terms: “Diversification behaves like the banker who lends you his umbrella when the sun is shining but wants it back the minute it begins to rain”. Nicely expressed!

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