Investors were challenged to think differently about their portfolios by the latest academic thinking from Stanford University at a one-day investment roundtable in California last week.
Chief investment officers from US public and corporate pension funds, endowments and foundations convened at Menlo Park, the home of Stanford University, for a one-day investment think-tank.
Three finance professors from Stanford presented their latest papers on active management, private equity and financial regulation, which were debated and workshopped by the investors in order to enable their application to the investors’ portfolios.
The roundtable sought to fuse the latest academic thinking with investment best practice to give investors an edge in their decision making.
This highly interactive discussion was jointly facilitated by conexust1f.flywheelstaging.com and Professor Stephen Kotkin from Princeton University, and supported by BNY Mellon and Lexington Partners.
Investment think-tank discussion points
1. Active management: measuring manager skill
The Nobel Prize awards in economic science in 2013 underscored the continuing debate about efficient versus irrational markets, and active versus passive portfolio management.
Professor Jonathan Berk’s research offers a rigorous approach to these issues, including delegated money management, asset pricing, valuations of firms’ growth potential, firms’ capital structure decision, and the interactions between labor markets and financial markets. He also studies the question of individual rationality in experimental settings.
The paper for this conference, which presupposes knowledge of another paper to be read, uses the value that a mutual fund extracts from capital markets as the measure of skill.
The paper finds that the average mutual fund has used this skill to generate about $2 million a year. The paper documents large cross-sectional differences in skill that persist for as long as 10 years.
It further documents that investors recognize this skill and reward it by investing more capital with better funds. Better funds earn higher aggregate fees, and there is a strong positive correlation between current compensation and future performance.
Professor Jonathan Berk, the A.P. Giannini Professor of Finance at the Stanford Graduate School of Business, has coauthored two finance textbooks: Fundamentals in Finance; and Corporate Finance, which remains the most successful first edition textbook ever published in financial economics, and is a standard text in nearly all top MBA programs around the world.
His research has won numerous awards, including the TIAA-CREF Paul A. Samuelson Award, the Smith Breeden Prize, Best Paper of the Year in the Review of Financial Studies, and the FAME Research Prize.
His article, “A Critique of Size-Related Anomalies”, was selected as one of the two best papers ever published in the Review of Financial Studies, and was also honored as one of the 100 seminal papers published by Oxford University Press.
Berk has received the Graham and Dodd Award of Excellence, the Roger F. Murray Prize, and the Bernstein Fabozzi/Jacobs Levy Award, in recognition of his influence on the practice of finance.
Berk was born and grew up in Johannesburg, South Africa, and received his PhD in finance from Yale University.
2. Overweighting and underperformance: evidence from limited partner private equity investments
This paper, “Local Overweighting and Underperformance: Evidence from Limited Partner Private Equity Investments”, coauthored with Yael Hochberg, examines the home-state bias in institutional investors’ private equity allocations.
This effect is particularly pronounced for public pension funds, where limited partners allocate around 10 per cent more of their private equity portfolios to home-state investments than would be predicted by the investment behavior of out-of-state investors.
Public pension funds’ in-state investments achieve performance that is lower by 2 to 4 percentage points than both their own equivalent out-of-state investments and equivalent investments in their state managed by out-of-state investors.
Professor Joshua Rauh, Professor of Finance at Stanford Graduate School of Business and a Senior Fellow at the Hoover Institution, has attracted national media coverage for his studies of state and local pension systems in the United States. He has won numerous awards for his research papers.
“Investment and Financing Constraints: Evidence from the Funding of Corporate Pension Plans” was awarded the 2006 Brattle Prize for the outstanding research paper on corporate finance published in the Journal of Finance.
“Public Pension Promises: How Big Are They and What Are they Worth?” coauthored with Robert Novy-Marx, won the Smith Breeden Prize for the outstanding research paper on capital markets published in the Journal of Finance.
“Earnings Manipulation, Pension Assumptions and Managerial Investment Decisions”, coauthored with Daniel Bergstresser and Mihir Desai, won the Barclays Global Investor Best Symposium Paper from the European Finance Association and appeared in the Quarterly Journal of Economics.
Professor Rauh received his PhD from the Massachusetts Institute of Technology.
3. The banker’s new clothes: what’s wrong with banking and what to do about it
The past few years have shown that risks in banking can impose significant costs on the economy. Many claim, however, that a safer banking system would require sacrificing lending and economic growth. Professor Anat Admati’s work reveals that the narratives used by bankers, politicians, and regulators to rationalise the lack of reform are invalid.
Professor Admati argues it is possible to have a safer and healthier banking system without sacrificing any of the benefits of the system, and at essentially no cost to society. Banks are as fragile as they are not because they must be, but because they want to be – and they get away with it. Whereas this situation benefits bankers, it distorts the economy and exposes the public to unnecessary risks.
Weak regulation and ineffective enforcement allowed the buildup of risks that ushered in the financial crisis of 2007-2009. Much can be done to create a better system and prevent crises. Yet the lessons from the recent crisis have not been learned.
Professor Anat Admati is the George G.C. Parker Professor of Finance and Economics at the Graduate School of Business, Stanford University.
She has written extensively on information dissemination in financial markets, trading mechanisms, portfolio management, financial contracting and, most recently, on corporate governance and banking.
Since 2010, she has been active in the policy debate on financial regulation, particularly capital regulation, writing research and policy papers and commentary. She is a co-author of the book, The Bankers’ New Clothes: What’s Wrong with Banking and What to Do about It.
Professor Admati received her BS from the Hebrew University in Jerusalem and her MA, MPhil and PhD from Yale University.
She is the recipient of a Sloan Research Fellowship, a Batterymarch Fellowship, and multiple research grants.
She is a fellow of the Econometric Society, and has served as a board member of the American Finance Association and on multiple editorial boards.
She also serves on the FDIC Systemic Resolution Advisory Committee.
Delegates
Anat Admati, professor of finance and Economics, Stanford University
Eric Baggesen, senior investment officer for asset allocation and risk management, California Public Employees’ Retirement System (CalPERS)
Jonathan Berk, professor of finance, Stanford University
Mary Cahill, chief investment officer, Emory University
David Cooper, chief investment officer, Indiana Public Retirement System (PERF)
John Donaghey, head of North American institutional distribution, BNY Mellon Investment Management
Hershel Harper, chief investment officer, South Carolina Retirement Systems
MaDoe Htun, chief investment officer, William Penn Foundation
Jennifer W. Kheng, principal, Lexington Partners
Stephen Kotkin, professor, Princeton University
William Lee, VP, pension & foundation investments, chief investment officer, Kaiser Permanente
Jamie Lewin, head of manager research and performance analytics; chief investment officer, BNY Mellon Investment Management; Lockwood Advisors, a BNY Mellon co.
David Long, senior vice president and chief investment officer, Healthcare of Ontario Pension Plan
Farouki Majeed, chief investment officer, Ohio School Employees Retirement Systems (OHSERS)
Tom Newby, partner, Lexington Partners
Joshua Rauh, professor, Stanford University
Stan Rupnik, chief investment officer & interim executive director, Illinois Teachers’ Retirement System
John Skjervem, chief investment officer, Oregon State Treasury
Colin Tate, chief executive, Conexus Financial
Amanda White, editor of conexust1f.flywheelstaging.com
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