Library
The following is a list of articles and empirical research on the subjects of Asset Allocation, Trading, Mean Reversion, Securities Selection and Fixed Income securities. The research supports the investment philosophy of Aros Capital Partners.
Asset allocation
Ibbotson, R. G and Kaplan, P. D. (2000): Does Asset Allocation Policy Explain 40%, 90%, or 100% of Performance? Financial Analysts Journal vol. 56.
Abstract
In this study Ibbotson & Kaplan document the importance of asset allocation. They conclude the following:
1) 90% of the variability of returns across time is explained by asset allocation policy
2) 40% of the variation of returns across funds is explained by differences in asset allocation policy
3) 100% of the return amount is explained by asset allocation policy
This emphasizes why asset allocation is so important in fund management.
Larsen, A. L. and Pedersen, T. Q. (2006): Strategic Asset Allocation. Aarhus School of Business. In Danish.
Abstract
Larsen & Pedersen addresses the impact of return predictability on asset allocation for a long term investor. It is shown that the optimal asset allocation of a long term investor is materially different from that of a short term investor. Mean reversion in stock and bond returns introduces a timing element in the optimal asset allocation. This means that the optimal asset allocation becomes time varying and dependent on the state of world. The authors show that allowing for this time variation in the asset allocation has economic significance for a long term investor.
Larsen, A. L. (2007): Implications of Human Capital on Portfolio Choice: Are You a Stock or a Bond? Finans/Invest no. 2. In Danish.
Abstract
This article explores the effect of human capital on asset allocation. It is shown that the nature of an investor’s job has a significant influence on the optimal asset allocation. If the job is risky and cyclical, the investor should allocate more to bonds because the human capital more or less resembles the stock market. Conversely, if investor enjoys secure employment a larger proportion should be allocated to stocks since the human capital equates an investment in bonds.
Trading
Barber, B. M. and Odean, T. (2000): Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors. The Journal of Finance vol. LV.
Abstract
This study of 66,465 households shows that frequent trading is hazardous to investor’s wealth. In the period 1991-1996 investors engaged in frequent trading only earned 11.4% while the market returned a generous 17.9%. The message is clear: the more frequently investors trade, the poorer returns they get.
This article underpins our long term view on investment.
Mean Reversion
Fama, E. F. and French, K. R.: (1988): Permanent and Temporary Components of Stock Prices. The Journal of Political Economy vol. 96.
Abstract
Fama & French find that stock returns are mean reverting and contain a predictable component. This predictability is weak at short horizons, but grows and becomes meaningful at longer horizons. Thus, at a 3-5 year horizon the predictable component for small firms is estimated to be around 40% of the variance. For large firms this percentage falls to 25%.
Fama, E. F. and French, K. R.: (1988): Dividend Yields and Expected Stock Returns. Journal of Financial Economics vol. 22.
Abstract
Fama & French provide evidence that stock returns are mean reverting and predictable from dividend yields. Like other studies, they find that the predictability is weak at short horizons but it becomes significant at 2-4 year horizons.
We believe this predictability should be taken into account in investment decisions.
Poterba, J. M. and Summers, K. R.: (1988): Mean reversion in stock prices - Evidence and Implications. Journal of Financial Economics vol. 22.
Abstract
Using a different methodology Poterba & Summers document that stock returns are mean reverting over longer horizons. Using data for 18 international equity markets they find that transitory components account for more than half of the monthly return variation. The fact that stock returns contain a transitory component implies that the stock market is less risky for long horizon investors.
Cochrane, J.: (2008): The Dog That Did Not Bark: A Defence of Return Predictability. The Review of Financial Studies vol. 21.
Abstract
In this paper Cochrane provides alternative evidence of return predictability. He shows that in order to generate the observed variation in dividend yields either stock returns or dividend growth must be predictable. Further, he finds that the latter is not the case thereby providing supportive evidence of predictable time variation in long horizon stock returns.
Security Selection
Fama, E. F. and French, K. R.: (1998): Value versus Growth: The International Evidence. Journal of Finance vol. LIII.
Abstract
This study documents the outperformance of value stocks around the world. For the period 1975 through to 1995, the difference between the average returns on global portfolios of high and low book-to-market stocks is 7.68% per year, and value stocks outperform growth stocks in twelve of thirteen major markets. This accentuates the need to differentiate between great companies and great stocks and further supports our mantra of never paying a premium for a “great” company.
Fixed income securities
IMF Country Report No. 07/123: March 2007: The Danish Mortgage Market — A Comparative Analysis
Abstract
The Danish mortgage system is among the most sophisticated housing finance markets in the world and presents some unique characteristics. The combination of a
tight regulatory framework with developed specialized, “in-house” expertise in lending and
credit assessment, and in wholesale funding and risk management has translated into a highly
rated system (and institutions), This is stated in a publication from IMF from March 2007.
BIS Quarterly Review: March 2004: The Danish Mortgage market
Abstract
As housing finance evolves, are there reasons to follow the Danish model? This is a case study of one of the world’s most sophisticated housing finance markets, the Danish mortgage market. The article highlights some key differences between the Danish and US mortgage markets, which both offers a penalty-free option to prepay. US and Danish mortgage markets are globally exceptional in this regard. Published in BIS Quarterly Review, March 2004.