Multi-objective portfolio optimization of mutual funds under downside risk measure using fuzzy theory

Mutual fund is one of the most popular techniques for many people to invest their funds where a professional fund manager invests people's funds based on some special predefined objectives; therefore, performance evaluation of mutual funds is an important problem. This paper proposes a multi-objective portfolio optimization to offer asset allocation. The proposed model clusters mutual funds with two methods based on six characteristics including rate of return, variance, semivariance, turnover rate, Treynor index and Sharpe index. Semivariance is used as a downside risk measure. The proposed model of this paper uses fuzzy variables for return rate and semivariance. A multi-objective fuzzy mean-semivariance portfolio optimization model is implemented and fuzzy programming technique is adopted to solve the resulted problem. The proposed model of this paper has gathered the information of mutual fund traded on Nasdaq from 2007 to 2009 and Pareto optimal solutions are obtained considering different weights for objective functions. The results of asset allocation, rate of return and risk of each cluster are also determined and they are compared with the results of two clustering methods

The Mathematics of Market Timing

Market timing is an investment technique that tries to continuously switch investment into assets forecast to have better returns. What is the likelihood of having a successful market timing strategy? With an emphasis on modeling simplicity, I calculate the feasible set of market timing portfolios using index mutual fund data for perfectly timed (by hindsight) all or nothing quarterly switching between two asset classes, US stocks and bonds over the time period 1993--2017. The historical optimal timing path of switches is shown to be indistinguishable from a random sequence. The key result is that the probability distribution function of market timing returns is asymetric, that the highest probability outcome for market timing is a below median return. Put another way, simple math says market timing is more likely to lose than to win---even before accounting for costs. The median of the market timing return probability distribution can be directly calculated as a weighted average of the returns of the model assets with the weights given by the fraction of time each asset has a higher return than the other. For the time period of the data the median return was close to, but not identical with, the return of a static 60:40 stock:bond portfolio. These results are illustrated through Monte Carlo sampling of timing paths within the feasible set and by the observed return paths of several market timing mutual funds.Comment: 18 pages, 6 figure

Portfolio regulation of life insurance companies and pension funds

This paper examines the rationale, nature and financial consequences of two alternative approaches to portfolio regulations for the long-term institutional investor sectors life insurance and pension funds. These approaches are, respectively, prudent person rules and quantitative portfolio restrictions. The argument draws on the financial-economics of investment, the differing characteristics of institutions’ liabilities, and the overall case for regulation of financial institutions. Among the conclusions are: · regulation of life insurance and pensions need not be identical; · prudent person rules are superior to quantitative restrictions for pension funds except in certain specific circumstances (which may arise notably in emerging market economies), and; · although in general restrictions may be less damaging for life insurance than for pension funds, prudent person rules may nevertheless be desirable in certain cases also for this sector, particularly in competitive life sectors in advanced countries, and for pension contracts offered by life insurance companies. These results have implications inter alia for an appropriate strategy of liberalisation. 1 The author is Professor of Economics and Finance, Brunel University, Uxbridge, Middlesex UB3 4PH, United Kingdom (e-mail ‘[email protected]’, website: ‘www.geocities.com/e_philip_davis’). He is also a Visiting Fellow at the National Institute of Economic and Social Research, an Associate Member of the Financial Markets Group at LSE, Associate Fellow of the Royal Institute of International Affairs and Research Fellow of the Pensions Institute at Birkbeck College, London. Work on this topic was commissioned by the OECD. Earlier versions of this paper were presented at the XI ASSAL Conference on Insurance Regulation and Supervision in Latin America, Oaxaca, Mexico, 4-8 September 2000, and at the OECD Insurance Committee on 30 November 2000. The author thanks participants at the conference and A Laboul for helpful comments. Views expressed are those of the author and not necessarily those of the institutions to which he is affiliated, nor those of the OECD. This paper draws on Davis and Steil (2000)

Asset allocation, cross-class correlation and the structure of property returns

Practical applications of portfolio optimisation tend to proceed on a “top down” basis where funds are allocated first at asset class level (between, say, bonds, cash, equities and real estate) and then, progressively, at sub-class level (within property to sectors, office, retail, industrial for example). While there are organisational benefits from such an approach, it can potentially lead to sub-optimal allocations when compared to a “global” or “side-by-side” optimisation. This will occur where there are correlations between sub-classes across the asset divide that are masked in aggregation – between, for instance, City offices and the performance of financial services stocks. This paper explores such sub-class linkages using UK monthly stock and property data. Exploratory analysis using clustering procedures and factor analysis suggests that property performance and equity performance are distinctive: there is little persuasive evidence of contemporaneous or lagged sub-class linkages. Formal tests of the equivalence of optimised portfolios using top-down and global approaches failed to demonstrate significant differences, whether or not allocations were constrained. While the results may be a function of measurement of market returns, it is those returns that are used to assess fund performance. Accordingly, the treatment of real estate as a distinct asset class with diversification potential seems justified

Rational Attention Allocation Over the Business Cycle

The literature assessing whether mutual fund managers have skill typically regards skill as an immutable attribute of the manager or the fund. Yet, many measures of skill, such as returns, alphas, and measures of stock-picking and market-timing, appear to vary over the business cycle. Because time-varying ability seems far-fetched, these results call into question the existence of skill itself. This paper offers a rational explanation, arguing that skill is a general cognitive ability that can be applied to different tasks, such as picking stocks or market timing. Using tools from the rational inattention literature, we show that the relative value of these tasks varies cyclically. The model generates indirect predictions for the dispersion and returns of fund portfolios that distinguish this explanation from others and which are supported by the data. In turn, these findings offer useful evidence to support the notion of rational attention allocation.

Regulating private pension funds’ structure, performance and investments: cross-country evidence

A number of countries have introduced individual, privately managed defined-contribution accounts, where the value of the pension benefit will depend on accumulated contributions and investment returns. These schemes expose workers’ future pension benefits to a number of different risks. To try to mitigate these risks, reforming governments have often strictly regulated the pension fund management industry’s structure, performance, and asset allocation. Structural regulations often force workers to choose only one manager and one fund. So, workers are unable to diversify investments across funds, exposing them to aberrant behaviour by fund managers, and preventing portfolio adjustments according to the individual’s age, household characteristics, career profile and attitude to risk. Strict asset-allocation rules and relative performance criteria mean that pension funds often invest and perform almost identically, removing any substantive choice for workers over the allocation of their pension fund’s assets and the portfolio’s risk and returns. Concentration in the pension fund management industry is found to be higher in the new pension systems of Latin America and Eastern Europe than in most OECD countries. Concentration might be because the new pension markets are smaller than in countries with more established funded pension systems, but it could also be because of restrictions on industry structure. In Latin America, asset allocation and performance is nearly identical across pension funds. So-called ‘herding’ behaviour is almost a defining characteristics of these pension regimes. Again, this reflects, at least in part, asset allocation restrictions and strict performance regulation. There is also evidence that pension funds have often under-performed simple portfolios composed of market indices of stocks and bonds. All the rules imposed in the new systems of Latin American and Eastern Europe seem to be more stringent than in the OECD, with one exception: portfolio limits. Some OECD countries have a tighter investment regime than countries such as Argentina, Chile, Colombia, Peru and Poland. But OECD countries tend to have fewer barriers to entry and impose fewer constraints on performance than Latin American and Eastern European countries

Portfolio Constraints and Contagion in Emerging Markets

The objective of this paper is twofold: (1) to analyze an optimal portfolio rebalancing by a fund manager in response to a "volatility shock" in one of the asset markets, under sufficiently realistic assumptions about the fund manager's performance criteria and portfolio restrictions; and (2) to analyze how the composition of the investor base determines the sensitivity of equilibrium asset prices to a shock originating in one of the fundamentally unrelated asset markets. The analysis confirms that certain combinations of portfolio constraints (notably short-sale constraints and benchmark-based performance criteria) can create an additional transmission mechanism for propagating shocks across fundamentally unrelated asset markets. The paper also discusses potential implications of recent and ongoing changes in the investor base for asset price volatility in emerging markets. Copyright 2006, International Monetary Fund

Optimal Timing in Trading Japanese Equity Mutual Funds: Theory and Evidence

This paper provides both theoretical and empirical analyses of market participants' optimal decision-making in trading Japanese equity mutual funds. First, we build an intertemporal decision-making model under uncertainty in the presence of transaction costs. This setting enables us to shed light on the investors' option to delay investment. A comparative analysis shows that an increase in uncertainty over the expected rate of return on mutual funds has a negative impact not only on market participants' buying behavior but also on their selling behavior. In addition, a several percent increase in front-end loads and redemption fees is likely to change the optimal holding ratio of mutual funds in investors' portfolios, by up to 10 percent. Second, we empirically examine the theoretical implications using daily transaction data of selected equity mutual funds in Japan. By estimating a panel data model, we conclude that for the sample period, from August 2000 to July 2001, investment behavior has been rational in light of our theoretical model. Our results suggest that investors are likely to rationally postpone their purchases of equity mutual funds under the present circumstances of low expected returns, high degree of uncertainty, and high trading costs.