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Food & Mood Group

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Yeremey Savin
Yeremey Savin

Investors And Markets: Portfolio Choices, Asset... TOP

To investigate how retail investors translate ESG information into portfolio choices, we design a computerized asset-market experiment that mimics a real-world trading environment. Participants were recruited using the online platform Prolific. The sample consists of 584 U.S. citizens above the age of 18. The experiment was followed by a questionnaire, which was constructed with the help of Unipark.

Investors and Markets: Portfolio Choices, Asset...

Stocks, bonds, and cash are the most common asset categories. These are the asset categories you would likely choose from when investing in a retirement savings program or a college savings plan. But other asset categories - including real estate, precious metals and other commodities, and private equity - also exist, and some investors may include these asset categories within a portfolio. Investments in these asset categories typically have category-specific risks. Before you make any investment, you should understand the risks of the investment and make sure the risks are appropriate for you.

You can rebalance your portfolio based either on the calendar or on your investments. Many financial experts recommend that investors rebalance their portfolios on a regular time interval, such as every six or twelve months. The advantage of this method is that the calendar is a reminder of when you should consider rebalancing.

It is important to note that even those studies which analyze the portfolio holdings of individual investors (e.g., Dimmock et al., 2020; Kumar, 2009; Mitton & Vorkink, 2007) use skewness proxies at the asset level.

MPT works under the assumption that investors are risk-averse, preferring a portfolio with less risk for a given level of return. Under this assumption, investors will only take on high-risk investments if they can expect a larger reward.

At every point on the Efficient Frontier, investors can construct at least one portfolio from all available investments that features the expected risk and return corresponding to that point. A portfolio found on the upper portion of the curve is efficient, as it gives the maximum expected return for the given level of risk.

So how did this play out in the Great Recession of 2008? According to Markowitz, investors that limited risk during the recession kept a percentage of their portfolios in lower-risk U.S. Treasure bonds; these investments were top performers, while stocks and corporate bonds took a dive.

The asset return depends on the amount paid for the asset today. The price paid must ensure that the market portfolio's risk / return characteristics improve when the asset is added to it. The CAPM is a model that derives the theoretical required expected return (i.e., discount rate) for an asset in a market, given the risk-free rate available to investors and the risk of the market as a whole. The CAPM is usually expressed:

Low-carbon pure plays are, in effect, taking this thinking one step further. They are betting heavily on building future-proof, low-carbon businesses while divesting themselves of legacy, high-carbon portfolios which could create management distractions and present investment propositions that are too mixed for both equity and debt investors.

If all investments have the same expected return independent of risk, investors seeking maximum returns for minimum risk should concentrate exclusively on minimizing risk. This is the explicit objective of the minimum variance portfolio.

This is curious for a number of reasons. First, the authors do not cite evidence that investors use these estimation windows to form optimal portfolios in practice. Thus, there is no reason to believe their methodology represents a meaningful use case for optimization.

We apply this approach to calculate the number of independent sources of risk that are available to investors in each of our test universes. Using the full data set available for each universe, we solve for the weights of the Maximum Diversification portfolios, and calculate the square of the Diversification Ratios. We find that the 10 industry portfolios; 25 factor portfolios; 38 sub-industry portfolios; and 49 sub-industry portfolios produce 1.4, 1.9, 2.9, and 3.7 unique sources of risk, respectively. Results are summarized in Figure 3.

This should not be surprising. The market cap weighted portfolio is mean-variance optimal if returns to stocks are explained by their β to the market, so that stocks with higher β have commensurately higher returns. However, we showed in our whitepaper on portfolio optimization that investors are not sufficiently compensated for bearing extra risk in terms of market β. Thus, investors in the market cap weighted portfolio are bearing extra risk, which is not compensated.

While optimization based methods rivaled the performance of naive methods for the cases investigated in this paper, we acknowledge that our test cases may not be representative of real-world challenges faced by many portfolio managers. Many problems of portfolio choice involve large numbers of securities, with high average correlations. Investors will also often demand constraints on sector risk, tracking error, factor exposures, and portfolio concentration. Other investors may run long/short portfolios, which introduce much higher degrees of instability.

Whether home bias is a puzzle depends on the portfolio allocation that one uses as a theoretical benchmark. For instance, home bias in equity portfolio is a puzzle when assessed through the lens of a simple international capital asset pricing model (CAPM) with homogeneous investors. This model predicts that investors should hold world market portfolios, namely a portfolio with the share of domestic asset equal to the share of those assets in the world market portfolio. For instance, since the share of US equity in the world capitalization in 2016 was 56%, then US investors should allocate 56% of their equity portfolio into local assets, while investing the remaining 44% into foreign equities. Instead, foreign equity comprised just 23% of US equity portfolio in 2016, hence the equity home bias.

Who are they good for? Corporate bond funds can be an excellent choice for investors looking for cash flow, such as retirees, or those who want to reduce their overall portfolio risk but still earn a return. Short-term corporate bond funds can be good for risk-averse investors who want a bit more yield than government bond funds. 041b061a72


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