Anthony Loviscek

Stock selection based on Morningstar’s ten-year, five-star general equity mutual funds

Abstract Recent research suggests that the individual investor can build stock portfolios that outperform broad market indices. Based on this research and on evidence supporting the persistence of mutual fund performance, we test whether or not the individual investor can build market-superior portfolios from stocks selected from the top holdings of Morningstar’s ten-year, five-star general equity mutual funds. We use modern portfolio theory to construct the portfolios. Although the portfolios tend to outperform the S&P 500 for the 1990s, we conclude that the evidence is not strong enough to recommend this stock selection strategy to the individual investor.

Assessing the impact of political unrest on currency returns: A look at Latin America

Abstract This study assesses the impact of major episodes of political unrest, such as assassinations, bombings, and coup attempts, on the currency returns of Brazil, Chile, Colombia, Mexico, Peru, and Venezuela. Using daily data for the 1990s and standard modeling from the efficient markets literature, we find that instances of political unrest lead to a significant drop in currency returns that lasts for up to twelve weeks. We discuss some implications of these results for investors, researchers, and practitioners.

An Examination of Hedge Fund Survivorship Biasand Attrition Before and During the GlobalFinancial Crisis

The impact of the recent global financial crisis has been deep and broad, blanketing the financial and economic landscape and hammering the hedge fund industry. Using both active and inactive hedge fund return data from the CISDM database from January 1994 to March 2009, the authors measure survivorship bias and account for the attrition rates of hedge funds before and during the crisis. In contrast to their expectations, they do not find survivorship bias to be notably significant during the global financial crisis. However, they discover unprecedented attrition rates, along with record declines in assets under management and fund closures, during the crisis. In addition, the authors’ results from the pre-crisis period reveal that survivorship bias and attrition differ dramatically by strategy and size, yet this pattern disappears during the global financial crisis, as all strategies and sizes experienced unprecedented attrition, indicating that few funds were spared the crisis.

Seigniorage and the Mexican financial crisis

Fiscal imprudence and political wavering are frequently cited as the primary causes of Mexicos financial crisis of the 1980s. While these views have merit, they tend to overlook the seigniorage from money creation. Using the Cagan model and an econometric procedure that does not rely on any particular formation of expectations, we find evidence that the government used seigniorage to pursue a revenue-maximizing inflation tax. The results have two implications. First, monetary management had a larger impact on the crisis than suggested in the literature. Second, an analysis of monetary management may yield new insights into the causes and consequences of the crisis.

“The lost decade”: an MPT perspective

Purpose - – The purpose of this paper is to test the efficacy of an application of modern portfolio theory (MPT) from 2000 through 2009, a period during which the annual rate of return on the S & - P 500 is negative. The financial media have called this period “the lost decade” for investors. Design/methodology/approach - – Using monthly data, the author uses a series of annual out-of-sample tests to compare the risk-reward performances of MPT portfolios against those of the S & - P 500. Findings - – The author finds that the MPT portfolios outperformed the S & - P 500. During the “lost decade”. They generated a cumulative return of over 77 percent compared to a cumulative return of -9.1 percent on the S & - P 500. Moreover, the MPT portfolio Research limitations/implications - – The MPT portfolios are relatively small, and might not be well diversified. That said, they comprise a core set of securities that could help investors achieve a risk-reward performance that exceeds that of the S & - P 500. Practical implications - – The results suggest that investors should not overlook the potential of MPT, despite its theoretical and practical limitations, to provide above-average returns at below-average risks. Originality/value - – This is the first study to show the efficacy of MPT during a period in which it was criticized at having failed investors when they needed it most.

The impact of the global financial crisis on firm‐level risk of the S&P 500

Purpose - This paper aims to assess the impact of the global financial crisis of 2007-09 on the risk structure of S&P 500 firms by examining their market, active, and residual risks before and during the crisis. Design/methodology/approach - The classic one-factor model is estimated for each firm in the S&P 500 to decompose risk into market, active, and residual components. Five sets of regression estimates based on monthly return data are used: 2002-06, 2003-07, 2004-08, 2005-09, and 2006-10. The estimates provide insight into the risk structure of S&P 500 firms before and during the crisis. Findings - The average correlation coefficient between S&P 500 firms rose during the crisis from 0.20 to 0.35, an increase of 75 percent. Although the results indicate that active and residual risks are significant across the firms and across the periods, the impact of the financial crisis was mostly on market risk. The increase in risks was pronounced for financial firms, especially insurance companies, and industrial firms, especially “hard” manufacturing. Research limitations/implications - Because the study focuses on the global financial crisis of 2007-09, researchers should be careful about generalizing the results to the post-crisis period. Practical implications - Investors should be aware that equity portfolio risk reduction during major crises can be hard to achieve because the average correlation coefficient between stock returns may rise significantly, crimping the efficacy of diversification. Originality/value - It was very difficult for equity investors to shield themselves from the risk associated with the global financial crisis of 2007-09.

Should Preferred Stock Funds Be Included in MutualFund Portfolios

Should preferred stock funds, despite their lack of attention from Wall Street, academia, and the financial media, be preferred in mutual fund portfolios? To address this question, we construct mean–variance-efficient portfolios from U.S.-centric mutual funds that represent common stocks, Treasury bills, Treasury bonds, corporate bonds, real estate investment trusts, and preferred stocks to determine whether a preferred stock fund meets the standards for inclusion in mutual fund portfolios. We also conduct robustness checks on the results and perform out-of-sample tests on portfolio performance with and without the preferred fund. Overall, the evidence indicates that a preferred stock fund allocation in the range of 5%–15% can reduce portfolio risk while at least preserving portfolio return, providing a cushion for portfolio managers of balanced funds and for income-seeking investors.

An unpleasant small-stock effect in manufacturing: the case of the dependent buyer

Purpose The purpose of this paper is to determine if there is a significant difference in the investment risks between small-cap manufacturers that heavily depend on one or a few buyers, referred to as “dependent-buyers,” and small-cap manufacturers that have a more diversified customer base. If there is a significant difference both statistically and economically, then investors need to be aware of the dependent-buyer effect in their security selection and portfolio construction efforts. Design/methodology/approach Using large samples of firm-level data from 2000 through 2011, the authors employ standard risk estimation modeling to compute βs, idiosyncratic risks, and total risks of both dependent-buyer firms and firms with a more diversified customer base. Findings The authors find that the βs, idiosyncratic risks, and total risks of dependent-buyer firms are much greater than that of firms not in dependent relationships. These differences are both statistically and economically significant. Research limitations/implications Buyer-supplier relationships can change quickly, and so a firm that has a diversified base in one period, for example, could be a dependent-buyer in the next period. Much depends on the reporting accuracy of firms and the ability of the securities exchange commission (SEC) to track the relationships. Practical implications First, the risk of individual small-cap stocks is likely to be greater than perceived from macro-level data, leading to the need for more securities if idiosyncratic risk is to be eliminated. Second, small-cap investors have the opportunity to enhance portfolio construction efficiency by referencing data published by the SEC. Third, most investors interested in small-cap manufacturing stocks should find it prudent to allocate a large percentage of their small-cap investments to an index fund. While this may sacrifice higher returns, it also reduces the probability of experiencing an unpleasant small-stock effect. Originality/value This is the first study to show that the difference in investment risks between small-cap manufacturers that depend on one or a few firms for their outputs and small-cap manufacturers that have a well-diversified customer base is statistically and economically significant, information that should be valuable to investors in their security selection and portfolio construction efforts.