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What Does It Take to Safeguard a Legacy in Asset Management?

by Rachel Layne

Diverse hiring, deep research, and a collaborative culture have defined Brown Capital's successful investment approach. But would those qualities endure after its founder retires? A case study by Luis Viceira and Emily McComb explores how the second-largest Black-founded investment firm is preparing for its next phase.

Why Global Investments Are Still a Good Bet

by Michael Blanding

International markets often move together, so does a global investment portfolio even make sense anymore? Luis Viceira still sees plenty of advantages in looking beyond home markets. Open for comment; 0 Comments.

The Promises and Limitations of Big Data

by Sean Silverthorne

Recent stories chart the rise of big data, its impact on business, and how it affects our lives every day. Open for comment; 0 Comments.

The Dow at 20,000: What's That All About?

by Jim Aisner

It took more than a century for the Dow Jones Industrial Average to hit 20,000. Investment management expert Luis Viceira discusses how this happened, what it means, and how high the Dow may go in the future. Open for comment; 0 Comments.

Vanguard, Trian And The Problem With 'Passive' Index Funds

by Michael Blanding

Index funds are the major shareholders in many large- and medium-sized public companies, but their passive investment nature offers few checks on those companies’ executives, says Luis Viceira. Open for comment; 0 Comments.

Why Millennials Flock to Fintech for Personal Investing

by Michael Blanding

New tech-heavy financial firms are helping millennials invest, but with a twist. They are swapping out investment advisers for financial robots, and passing along the savings. Luis Viceira explains the rise of "fintech" in a new case study.

How Small Investors Can Bet Big on Brands They Love

Re: Luis M. Viceira

LOYAL3 allows consumers to make small stock purchases of companies they love. In this Cold Call podcast, Luis M. Viceira discusses LOYAL3's move into IPOs and the idea that shareholders make better customers. Open for comment; 0 Comments.

Companies Detangle from Legacy Pensions

by Michael Blanding

Although new defined benefit plans are rare, many firms must still fund commitments to retirees. Luis M. Viceira looks at the pension landscape and the recent emergence of insurance companies as potential saviors. Open for comment; 0 Comments.

Monetary Policy Drivers of Bond and Equity Risks

by John Y. Campbell, Carolin E. Pflueger & Luis M. Viceira

Given the importance of nominal bonds in investment portfolios, and in the design and execution of fiscal and monetary policy, financial economists and macroeconomists need to understand the determinants of nominal bond risks. This is particularly challenging because the risk characteristics of nominal bonds are not stable over time. In this paper the authors ask how monetary policy has contributed to these changes in bond risks. They propose a model that integrates the building blocks of a New Keynesian model into an asset pricing framework in which risk and consequently risk premia can vary in response to macroeconomic conditions. The model is calibrated to US data between 1960 and 2011, a period in which macroeconomic conditions, monetary policy, and bond risks have experienced significant changes. Findings show that two elements of monetary policy have been especially important drivers of bond risks during the last half century. First, a strong reaction of monetary policy to inflation shocks increases both the beta of nominal bonds and the volatility of nominal bond returns. Positive inflation shocks depress bond prices, while the increase in the Fed funds rate depresses output and stock prices. Second, an accommodating monetary policy that smooths nominal interest rates over time implies that positive shocks to long-term target inflation cause real interest rates to fall, driving up output and equity prices, and nominal long-term interest rates to increase, decreasing bond prices. The paper shows empirical evidence that the Fed monetary policy followed an anti-inflationary stance after 1979, but it has moved to a more accommodating, nominal interest rate smoothing policy since the mid 1990's. Consistent with the predictions of the model, the first period corresponds to a period of average positive Treasury-bond beta and stock-bond correlation, and the second period to a period of average negative bond beta and stock-bond correlation. Overall, results imply that it is particularly important to take account of changing risk premia. Key concepts include: This paper contributes to scholarship on monetary policy regime shifts exploring the implications of monetary policy regimes for asset values and the co-movement of stock and bond returns. In different periods of history, long-term Treasury bonds have played very different roles in investors' portfolios. During the 1970s and particularly the 1980s, for example, Treasury bonds added to investors' macroeconomic risk exposure by moving in the same direction as the stock market and real output growth, while since the mid-1990's Treasury bonds have provided investors with protection against deflation risk by moving in the opposite direction as the stock market and output growth. These authors' model allows for a detailed exploration of the monetary policy drivers of bond and equity risks. The increase in bond risks after 1979 is attributed primarily to a shift in monetary policy towards a more anti-inflationary stance. The more recent decrease in bond risks after 1997 is attributed primarily to an increase in the persistence of monetary policy interacting with continued shocks to the central bank's inflation target. Closed for comment; 0 Comments.

An Empirical Decomposition of Risk and Liquidity in Nominal and Inflation-Indexed Government Bonds

by Carolin E. Pflueger & Luis M. Viceira

The yields on US Treasury Inflation Protected Securities (TIPS) have declined dramatically since they were first issued in 1997. This paper asks to what extent the returns on nominal and inflation-indexed bonds in both the US and the UK can be attributed to differential liquidity and market segmentation or to real interest rate risk and inflation risk. Key concepts include: Over the 10 year period starting in 1999 the average annualized excess log return on 10 year TIPS equaled a substantial 4.16 percent, almost a full percentage point higher than that on comparable nominal US government bonds. These differential returns are notable, because both nominal and inflation-indexed bonds are fully backed by the US government. Moreover, the real cash flows on nominal bonds are exposed to surprise inflation while TIPS couponsand principal are inflation-indexed. The authors find strong empirical evidence for two different potential sources of excess return predictability in inflation-indexed bonds: real interest rate risk and liquidity risk. Empirical evidence is also provided showing that nominal bond return predictability is related not only to time variation in the real interest rate risk premium, but also to time variation in the inflation risk premium. Closed for comment; 0 Comments.

HBS Faculty Debate Financial Reform Legislation

by Staff

Harvard Business School professors Robert Steven Kaplan, David A. Moss, Robert C. Pozen, Clayton S. Rose and Luis M. Viceira share their perspectives on the Dodd-Frank Wall Street Reform and Consumer Protection Act, slated to be signed this week by U.S. President Barack Obama. Key concepts include: Overall, faculty see reasons for optimism as well as concern and caution. We need appropriate risk-taking and credit extension to fuel economic growth, says Robert Steven Kaplan. While the Dodd-Frank bill creates safeguards, will it discourage and impede these activities? According to David A. Moss, an open question is how the regulators will use the new authority granted to them. The Dodd-Frank bill fails to reform large mortgage finance institutions such as Fannie Mae, Freddie Mac, and the housing agencies, says Robert C. Pozen. While the bill does tackle some causes of the crisis, says Clayton S. Rose, it may increase risk to the U.S. financial system by skirting the issues of firms "too big to fail" and the excessive use of market-based short-term funding by financial firms. At first sight, Dodd-Frank has elements that indicate we are moving in the right direction, while other parts of the bill leave us uncertain about its future success, says Luis M. Viceira. Closed for comment; 0 Comments.

Inflation Bets or Deflation Hedges? The Changing Risks of Nominal Bonds

by John Y. Campbell, Adi Sunderam & Luis M. Viceira

Are nominal government bonds risky investments that investors must be rewarded to hold? Or are they safe investments, whose price movements are either inconsequential or even beneficial to investors as hedges against other risks? U.S. Treasury bonds have performed well as hedges during the financial crisis of 2008, but the opposite was true in the late 1970's and early 1980's. John Y. Campbell, a Visiting Scholar at HBS, Harvard Ph.D. candidate Adi Sunderam, and HBS professor Luis M. Viceira explore such changes over time in the risks of nominal government bonds. Key concepts include: A changing covariance between nominal and real variables is of central importance in understanding the term structure of nominal interest rates. Analyses of asset allocation traditionally assume that broad asset classes have a stable structure of risk over time; these new results, however, suggest that in the case of nominal bonds, at least, this assumption is seriously misleading. Closed for comment; 0 Comments.

Bond Risk, Bond Return Volatility, and the Term Structure of Interest Rates

by Luis M. Viceira

This paper documents the existence of considerable variation over time in the covariance or correlation of Treasury bond returns with stock returns and with consumption growth. There are times in which bonds appear to be safe assets, while at other times they appear to be highly risky assets. The paper finds that time variation in bond risk is systematic and positively related to the level and the slope of the yield curve. These are factors that proxy for inflation and general economic uncertainty, inflation risk, and the risk premium on bonds. Key concepts include: The movement of bond returns together with stock returns (or consumption growth) can change significantly in business cycle frequencies. Bond risk changes over time, and these changes are correlated with time variation in the term structure of nominal interest rates. Closed for comment; 0 Comments.

The Excess Burden of Government Indecision

by Francisco J. Gomes, Laurence J. Kotlikoff & Luis M. Viceira

Virtually all U.S. policymakers, budget analysts, and academic experts agree that the United States faces a very serious, if not a grave, long-term fiscal problem. Yet few policymakers will publicly say how or when they would fix it, perhaps because they fear being the bearer of bad news and getting voted out of office. Delaying the resolution of fiscal imbalances incurs two costs, however. First, it leaves a larger bill for a smaller number of people to pay. Second, and of primary interest to this research, it perpetuates uncertainty, leading economic agents to make suboptimal saving, investment, and other decisions, and reducing welfare. This research identifies and measures this "excess burden" of government indecision and finds that it is economically significant. Key concepts include: Whatever policymakers gain from delaying bad news, delay fosters and exacerbates economic uncertainty. As individuals wait to learn the level of future Social Security benefits, the fact of having to wait materially affects their consumption, saving, and portfolio decisions. Most important, it reduces welfare. The result of government indecision, in this instance, can exceed more than .5 percent of individuals' resources, a significant amount. The excess burden is highly sensitive to the degree of risk aversion, the number of years one must wait to have the policy uncertainty resolved, and the size and probability of policy changes. People experience sizable welfare gains from learning early about future changes in benefits and tax rates regardless of their attitudes toward risk or the uncertainty they face about their own labor earnings. Closed for comment; 0 Comments.

Global Currency Hedging

by John Y. Campbell, Karine Serfaty-de Medeiros & Luis M. Viceira

This article is forthcoming in the Journal of Finance. How much should investors hedge the currency exposure implicit in their international portfolios? Using a long sample of foreign exchange rates, stock returns, and bond returns that spans the period between 1975 and 2005, this paper studies the correlation of currency excess returns with stock returns and bond returns. These correlations suggest the existence of a typology of currencies. First, the euro, the Swiss franc, and a portfolio simultaneously long U.S. dollars and short Canadian dollars are negatively correlated with world equity markets and in this sense are "safe" or "reserve" currencies. Second, the Japanese yen and the British pound appear to be only mildly correlated with global equity markets. Third, the currencies of commodity producing countries such as Australia and Canada are positively correlated with world equity markets. These results suggest that investors can minimize their equity risk by not hedging their exposure to reserve currencies, and by hedging or overhedging their exposure to all other currencies. The paper shows that such a currency hedging policy dominates other popular hedging policies such as no hedging, full hedging, or partial, uniform hedging across all currencies. All currencies are uncorrelated or only mildly correlated with bonds, suggesting that international bond investors should fully hedge their currency exposures. Key concepts include: It is striking that the U.S. dollar, Swiss franc, and euro are widely used as reserve currencies by central banks, and more generally as stores of value by corporations and individuals around the world. Interestingly, the euro, the Swiss franc, and a long-short position in the U.S. dollar and the Canadian dollar are negatively correlated with world equity markets. By contrast, other currencies such as the Australian dollar, the Canadian dollar, the Japanese yen, and the British pound are either uncorrelated or positively correlated with world stock markets. These patterns imply that international equity investors can minimize their equity risk by taking short positions in the Australian and Canadian dollars, Japanese yen, and British pound, and long positions in the U.S. dollar, euro, and Swiss franc. For U.S. investors, currency exposures of international equity portfolios should be at least fully hedged, and probably overhedged. Exceptions are the euro and Swiss franc, which should be at most partially hedged. Risk management demands for currencies by bond investors are small or zero, regardless of the home country of these investors, and regardless of whether these investors hold only domestic bonds or an international bond portfolio. Closed for comment; 0 Comments.

Optimal Value and Growth Tilts in Long-Horizon Portfolios

by Jakub W. Jurek & Luis M. Viceira

Long-term investors look for portfolio strategies that optimally trade off risk and reward, not in the immediate future, but over the long term. It is unrealistic to expect long-term investors to adopt an "invest and forget" strategy, but creating a portfolio strategy that adjusts asset allocations in response to changing risk premia, interest rates, and expected inflation remains a challenge in finance. Jurek and Viceira have devised a solution method that aims at a practical implementation of dynamic portfolio choice models with realistically complex investment opportunity sets. They have applied their method to study the role of value stocks and growth stocks in the portfolios of long-term investors, and have found that long-term investors might want to tilt their portfolios away from value stocks despite the fact that the average return on value stocks is larger than the average return on growth stocks (the so-called "value premium"). Their findings provide support for the idea that the superior performance of value stocks might reflect simply that they are riskier than growth stocks at long horizons. Key concepts include: The solution can be readily implemented for investment opportunity sets with any number of assets and state variables. On average, equity-only investors with short horizons optimally choose portfolios that are heavily tilted toward value and away from growth, regardless of the investor's risk aversion. Aggressive short-term investors find it best to tilt their portfolios toward value because of their higher average return. Conservative equity-oriented investors optimally tilt their portfolios toward value stocks because of their small return volatility and high correlation with growth. However, for investors with longer horizons, the optimal allocation to value decreases dramatically as the optimal allocation to growth increases. Value stocks appear to be riskier than growth stocks at long horizons because they tend to be more highly correlated with permanent shocks to the value of the aggregate stock market, while growth stocks appear to be more highly correlated with transitory shocks. In the presence of time varying risk premia, interest rates, and expected inflation, it is optimal for most investors to dynamically rebalance their portfolios in response to changes in investment opportunities. The paper finds that for long-horizon investors who can invest in equities, bond, and cash, welfare losses from adopting investment policies with infrequent reevaluation of portfolio weights are large, regardless of the investor's risk aversion. Closed for comment; 0 Comments.

New Challenges for Long-Term Investors

by Ann Cullen

Risk-reward. Rising interest rates. Stocks or bonds. The long-term investor has lots to ponder when setting asset allocation strategy, says HBS professor Luis M. Viceira. And the answers might not come with "conventional wisdom." Closed for comment; 0 Comments.