Geoff Warren

Designing an Investment Organization for Long-Term Investing

We address how investment management organizations might be built to successfully pursue long-term investing. A variety of recommendations and suggestions are put forward that address four building blocks: organizational; incentives; investment approach; and discretion over trading. A key message is the need to manage the principal-agency issues that occur across multi-layered operations, with the aim of building alignment with investing for the long run. Investment approaches should be focused around the drivers of long-term outcomes, rather than short-term price movements. We highlight the importance of commitment in terms of both funding, and towards those making the investment decisions; but note how commitment is associated with costs and trade-offs. An approach is presented for evaluating performance based on separating out the effects of long-term expected returns, changes in discount rates, and changes in expected long-term cash flows. Our discussions are illuminated by insights and examples drawn from the Future Fund.

Capacity Constraints in Hedge Funds: The Impact of Cohort Size on Fund Performance

We propose a method for identifying the presence of capacity constraints for hedge funds based around the concept of cohort size, measured by the total assets of all hedge funds applying a similar strategy to a fund of interest. We find that cohort size provides a better indicator of diseconomies of scale and hence potential fund performance than individual fund size viewed in isolation. Our analysis reveals a negative relation between cohort size and future returns both adjusted for hedge fund sector returns and the 7-factor model of Fung and Hsieh (2004). We also demonstrate that cohort size may influence the propensity of hedge funds to accept additional assets, and attenuates the relation between fund performance and future fund flows.

Global Equity Fund Performance: An Attribution Approach

We use portfolio holdings data to examine the performance of 143 global equity funds over the period 2002 to 2012. We find that the average global equity manager outperforms their benchmark by 1.2% to 1.4% per annum before fees. Attribution analysis reveals that the prime source of excess return relates to selecting stocks that beat their local markets. Modest contributions arise from country selection, most notably in emerging markets; while currency effects are mixed. Our findings support giving consideration to active management in global equity markets, at least for institutional accounts that pay fees below 1% per annum.

The Impact of Broker Market Structure on Stock Liquidity

We investigate the extent to which the liquidity of listed stocks is affected by the market structure under which stockbrokers provide a combination of stock trading, research, and investment banking services. Six market structures of differing degrees of competitiveness are identified for brokers operating in the Australian equity market. We find that less competitive structures tend to associate with lower stock liquidity; and that shifts in broker market structure align with changes in liquidity over time. Further, broker market structures appear to interact with the provision of services by brokers, such that additional services improve liquidity to a greater extent under less competitive structures. Our research shows that the market structure for brokerage services acts as an additional determinant of the market liquidity of stocks.

How Much Does Tax Erode Fund Excess Return

We model the tax drag from active funds management by simulating portfolios based on reported monthly holdings of 207 active Australian equity funds between July 2000 and December 2010, and then compare both pre-tax and after-tax fund returns versus those for passive indices modeled under the same assumptions. Tax drag erodes 65% of the 0.74% excess return in Broad Market funds, but only 21% of the 1.80% excess return in Small-Cap funds for Australian superannuation (pension) fund investors. We also find that tax drag varies with investment style; market state, and is most detrimental during bull markets; and fund turnover – although the relation between turnover and after-tax excess return is non-monotonic. For high-income individual investors, tax drag is exacerbated to the extent that active management only generates meaningful after-tax excess return for Small-Cap funds of certain styles. Our study highlights the importance of considering tax when choosing between active and passive funds management, as well as how tax impacts can vary according to the circumstances.