Scott Gibson

Missing the Marks: Dispersion in Corporate Bond Valuations Across Mutual Funds

We study the dispersion of month-end valuations placed on identical corporate bonds by different mutual funds. Such dispersion is related to bond-specific characteristics associated with liquidity and market volatility. The Trade Reporting and Compliance Engine (TRACE) could have contributed to the general decline in dispersion over our sample period, though other factors most likely played roles. Further tests reveal marking patterns to be consistent with returns smoothing behavior by managers. Funds with ambiguous marking policies and those holding “hard-to-mark” bonds appear more prone to smooth reported returns. From a regulatory perspective, we see little downside to requiring funds to explicitly state their marking standards. JEF classification: G12; G19; G29 Keyword: Mutual Funds; Bonds; Valuation; Fair Value; Corporate Bond Funds

The Effect of Decimalization on the Components of the Bid-Ask Spread

Previous empirical studies that decompose the bid-ask spread were done when securities traded in discrete price points equal to one-sixteenth or one-eighth of a dollar. These studies concluded that inventory and adverse-selection costs were economically insignificant compared to order-processing costs. Natural questions arise as to: (i) whether price discreteness allowed market makers to enjoy excess rents, thus reducing the significance of the inventory and adverse selection costs; (ii) whether discreteness decreased the traders’ incentives to gather information; or (iii) whether methodologies previously employed mis-estimated the inventory and the adverse-selection costs. We show that the recent conversion to decimal pricing results in significantly tighter spreads. However, the dollar value of spreads attributed to adverse selection and inventory costs do not change significantly. Almost all of the reduction occurs in the order-processing component. As a result, inventory and adverseselection costs now account for a significantly larger proportion of the traded spreads. A plausible explanation is that the minimum tick size constraint previously in place under fractional pricing allowed market makers to enjoy spreads that were larger than their actual costs.

Can Fund Managers Select Outperforming REITs? Examining Fund Holdings and Trades

Despite six empirical studies published since 2000 designed to assess fund managers’ REIT selection ability, their skill remains in question. Unlike previous studies, we examine fund holdings and trades of REITs to answer this question. This allows us to account for portfolio rebalancing that alters REIT-characteristic weights of fund portfolios. All REITs held by funds at each report date are matched to benchmark portfolios of REITs that share similar characteristics. Results show that real estate mutual fund managers, after controlling for size, property type shifting, and momentum, generated significant positive alpha with their securities selection ability as predicted by Grossman and Stiglitz (1980). To understand the sources of such ability, we examine whether fund managers that follow certain trading strategies outperform relative to other managers. The potential investment strategies we examine are related to geographic concentration, public and private real estate valuation, income and appreciation styles, and leverage of the underlying REITs. Exploring these investment strategies, we find that fund managers that focus on geographically concentrated REITs generate higher returns to investors, especially in the later years, consistent with the findings of Capozza and Seguin (1999).

Does Smart Money Move Markets

The authors split equity investors into two groups, one of “smart money” institutional investors and the other of individual investors. Using quarterly data, they examine how aggregate ownership flows between the two groups are related to stock returns. Except in one case, increases in institutional ownership are associated with positive returns, and reductions in institutional ownership with negative returns, and the positive relationship between institutional ownership flows and returns is not explained by within-quarter momentum trading. These findings are consistent with the belief that institutional investors play a price-setting leadership role in the equity markets. The exception to the positive association between institutional ownership flows and returns is for small-capitalization stocks; increases in institutional ownership of small-capitalization stocks that were prior losers are associated with negative returns (concentrated in the fourth quarter). This different return pattern for small-capitalization stocks is interpreted as consistent with institutions buying stocks at price discounts from individuals who are systematically selling to establish tax-deductible capital losses.

The Use of Fixed-rate and Floating-rate Debt for Hotels

A time-series simulation that compares hotel-industry revenue per available room (RevPAR) with London Interbank Offer Rate (LIBOR) indicates that hotel investors would fare more favorably with floating-rate loans than with the commonly used fixed-rate financing. Using data from 1987 through 2004, the study determined that LIBOR and RevPAR changes are strongly correlated, indicating a relationship of RevPAR and floating interest rates. Moreover, a simulation found that hotels using variable-rate mortgages would have been more likely to cover debt service in good times and bad than would hotels financed with fixed-rate loans. The correlation was strongest for midscale, limited-service properties but also operated for budget and resort deals. The relationship of RevPAR with floating rates suggests a reduction in the costs to borrowers and lenders arising from distressed loans.

Understanding first-day returns of hospitality initial public offerings

Excerpt] The decision for a company to issue shares publicly for the first time is not to be taken lightly. The manager-owner of a private firm must carefully weigh the benefits of an initial public offering (IPO) against the costs. Potential benefits include the ability to raise capital in the public markets on more attractive terms than in private circles; increased liquidity for managers and other insiders who wish to sell ownership stakes; and increased recognition and credibility with customers, employees, and suppliers. These benefits, however, come at considerable direct and indirect costs. For U.S. firms, the direct costs, such as investment banking commissions, average about 11 percent of IPO proceeds.1 Less obvious, but sometimes more painful for issuing firms, is an additional indirect cost commonly referred to as “IPO underpricing.”

Real estate private equity: the case of US unlisted REITs

Purpose – The purpose of this paper is to demonstrate how fixed‐share prices, as a structural flaw in private equity funds targeted to small‐unit investors, economically disadvantages those investors in favor of sponsors.Design/methodology/approach – The theoretical model incorporates fixed share prices with continuous investment opportunity and evaluates the wealth transfer from long‐term investors to marketing affiliates and soliciting dealers in the form of fees paid on the sale of shares to follow‐on investors.Findings – This result holds in the presence of high‐payout dividend policy that attempts to compensate for wealth transfer.Research limitations/implications – Should share prices be marked‐to‐market using real estate appraisals or another method, the unlisted REIT and related offerings, such as tenant‐in‐common funds, will be profitable for sponsors without economically disadvantaging long‐term investors.Practical implications – The findings from this research are useful to fund sponsors who de...

The Information Content of Put Warrant Issues

We show that put warrant issues can be used to signal a firms superior prospects to a market that is not aware of them. One benefit of using put warrants to signal, particularly for growth firms, is that a firm receives cash when sending the signal, instead of paying out cash. We establish conditions under which put warrants are issued in a separating equilibrium. We then test our theory using a new data set on put warrant issues. The data support our model: put warrant issuers strongly outperform their peers in the years after the put warrant issues.

Using Experimental and Neurological Data to Gain a Deeper Understanding of Realization Utility Theory

Starting with the premise that realization utility theory helps explain trading behavior, this study combines a carefully crafted experimental design with functional magnetic resonance imaging technology to offer a more inclusive examination of factors that affect REIT trading behavior beyond whether a REIT is simply trading up or down. We add to the nascent field of neurological real estate by finding that local gains/loss domains are more relevant than are global gain/loss considerations, financial skewness is a significant determinant of trading behavior, and that performance inside the REIT market influences how hard subjects think when performing tasks outside the market.

Practical Applications of Market Transparency and the Marking Precision of Bond Mutual Fund Managers

Recent research in The Journal of Portfolio Management investigates whether the introduction of TRACE—the US corporate bond pricing program run by the Financial Industry Regulatory Authority (FINRA) —has improved bond-valuation precision and price transparency. This report highlights the practical applications of the research findings. It is based on an in-depth interview with co-author John Merrick, Jr . of the College of William and Mary Raymond A. Mason School of Business .“ Our story here is that market transparency matters, in terms of improving valuations,” he says. Merrick and his co-authors, Gjergji Cici and Scott Gibson , (colleagues at the College of William and Mary), and Yalin Gündüz (of Deutsche Bundesbank ), present their findings in Market Transparency and the Marking Precision of Bond Mutual Fund Managers .