We develop a holdings-based statistic to measure the volatility of a fund's investment style characteristic profile over time. On average, funds with lower levels of style volatility significantly outperform more style-volatile funds on a risk-adjusted basis. We show that style volatility has a distinct impact on future fund performance compared to fund expenses or past risk-adjusted returns, with the level of indirect style volatility being the primary determinant of the overall effect. We conclude that deciding to maintain a less volatile investment style is an important aspect of the portfolio management process.

The past 15 years have seen the emergence of large infusions of private capital at levels previously accessible only in public markets One direct effect of these non-public fundraisings is the spawning of private entities with market valuations reaching $1 billion, thereby achieving the status of unicorns As the authors reported in an earlier study, by the end of 2015, there were 142 unicorns with an aggregate value exceeding $500 billion The conviction of many investors and managers at that time was that these companies could best create value by staying private, often by adopting governance structures focused on creating superior operating performance It was also widely believed that unicorns would remain outside the public markets longer and succeed in attracting even more private capital, thereby enabling their investors to capture a greater share of the increase in company value In this study, the authors examine how the characteristics and dynamics of ?the blessing? have changed in the past five years Despite the widespread view that the valuations and private financing trend fueling this market were not sustainable, the authors report that by March 2020, the ?net? number of unicorns had grown from 142 to 464, a number that doesn't reflect the transformation of over half of the 2015 sample through acquisition or public offering and their replacement by new unicorns Further, the cumulative market valuation of unicorns more than doubled from $500 billion to $1 37 trillion, representing growth far greater than that in the public equity markets (some 26% per annum, as compared to 9% for the S&P 500) over the same period?and the blessing has become more diversified, both in terms of industry and geographical location The authors also consider what happens when unicorns ?graduate? to a different organizational form by means of an IPO, private buyout, or business failure Analyzing the 107 firms that departed the sample between 2015 and 2020, the authors report that the average lifespan of a unicorn from its founding date to its exit date has been 9 5 years, indicating that such firms indeed remain privately owned for a longer time than in the past Additionally, the study finds that the founders and initial investors in unicorns have fared quite well, cashing out their initial investment at almost six times invested capital, on average These private investment performance metrics have been significantly higher than the returns to public shareholders in the same firms during the post-IPO period, signifying that unicorn investors have captured much more of the value created in the company's growth phase than public stockholders

Practical Applications Summary In The Use and Value of Financial Advice for Retirement Planning, from the Winter 2020 issue of The Journal of Retirement, W. Van Harlow, formerly of Empower Retirement; Keith Brown of the University of Texas; and Stephen Jenks of Empower Retirement examined the characteristics of individuals who received professional advice for retirement planning and the economic value of the results. The authors surveyed more than 4,000 working households to assess their demographics as well as their investment and behavioral characteristics. The results reveal that the retirement income replacement earned by advised households tends to be 15 percentage points higher than that of unadvised households. TOPICS: Retirement, quantitative methods, portfolio construction

Offering professional advice around the retirement planning process represents an important component of the financial services industry. The authors examine the demographic, investment, and behavioral characteristics of individuals who obtain this advice as well as the economic value that it ultimately adds. Using a survey of more than 4,000 working households, they find that wealth and income levels are positively correlated with the decision to engage a professional advisor, as are factors such as marital status, age, and education level. To assess the value added by this advice, the authors develop a unique metric of retirement income replacement that incorporates health-based life expectancy and household-specific financial circumstances. The approach estimates the percentage of annual pre-retirement income that a household will be able to spend each year in retirement. The authors establish the unconditional finding that advised households generate significantly larger proportions of post-employment spending (both gross and net of Social Security benefits) than do nonadvised households. Controlling for additional explanatory factors, we find that an advisor adds more than 15 percentage points of income replacement in retirement. These findings support the conclusion that obtaining and implementing financial advice in the retirement planning process leads to a demonstrable increase in the level of sustainable retirement spending. TOPICS: Retirement, quantitative methods, portfolio construction Key Findings • Households using financial advisors, on average have higher incomes, and are wealthier, married, more highly educated, more confident in their retirement planning, and more disciplined in their financial process. • A new metric to quantify the value of financial advice is developed focusing on retirement income replacement and incorporating health-based life expectancy and household-specific financial circumstances. • Regression and nearest-neighbor matching methods to control for confounding variables both indicate a significant lift of approximately 15 percentage points in the retirement income replacement score resulting from the use of a financial advisor.

Life expectancy varies greatly with health conditions, but very rarely is this relationship incorporated into retirement investment planning. This is surprising given that the vast majority of older households have one or more adverse health conditions. The authors show that the savings required to fund a successful retirement for someone with one of several diseases whose impact on life expectancy has been estimated can be reduced by as much as 26% for females and 33% for males relative to the savings required for a healthy individual. Similarly, the savings required to fund healthcare expenses in retirement can be reduced by 29% to 39%. The interaction of projected health costs and the effect of disease on life expectancy have counterintuitive effects on retirement planning. For example, the higher retiree healthcare expenses associated with conditions such as diabetes and tobacco use are offset by reduced life expectancies. The net effect is that, in certain health states, less savings are required for healthcare than would be necessary for a healthy individual. TOPICS:Retirement, wealth management

Recent research shows that more highly concentrated portfolios produce superior risk-adjusted returns. The untested premise is that it is the most skillful managers who hold the most concentrated portfolios. In this article, the authors formally examine the implicit assertion that the initial portfolio concentration decision is related to a manager’s inherent investment skill. First, they present a theoretical model indicating that the greater the manager’s skill level, the more concentrated the portfolio should be. Second, they conduct a simulation analysis of the capacity to make accurate ex ante security return forecasts; they show that skilled managers would select as few as 5% of the available securities and that the portfolio concentration decision is directly proportional to investment prowess. Finally, they provide an empirical examination of the actual skill–concentration relationship for actively managed equity mutual funds over 2002–2015 and document that managers who demonstrated past skill do form portfolios with higher concentration levels. The authors conclude that talented asset managers should and actually do hold more concentrated portfolios and that the extent of this concentration decision is meaningfully related to forecasting skill. TOPICS:Manager selection, mutual fund performance, equity portfolio management Key Findings • The authors analyze the level of skill that an active manager must have to justify the decision to form a concentrated set of security holdings rather than a broadly diversified portfolio. • Using a conceptual model and a simulation, they establish a strong direct connection between a manager’s forecasting talent and the portfolio concentration decision. Optimal portfolio sizes decline to as little as 5% of the investable universe with increasing skill. • The authors develop three portfolio concentration measures and demonstrate with an extensive set of historical mutual fund returns that managers with the best past performance do indeed hold the most concentrated portfolios over time.

In a recent article in this journal, the authors documented the growing tendency of emerging growth companies to raise substantial equity while remaining privately held through private IPOs, or PIPOs. PIPO financing has created scores of “unicorn” firms—private enterprises with imputed market values of $1.0 billion or more—while allowing them to avoid the challenges of being publicly traded. But as has also been noted, the PIPO process, with its multiple financing rounds and increasingly complex terms, has almost certainly result in some inflated market valuations.Along with inflated values, the contracting process and many of the provisions that result from it often have economic consequences that are poorly understood by at least some of the participants, including the potential for significant wealth transfer between stakeholders as well as overall destruction of enterprise value. And the term sheets containing such provisions appear to become even more “opaque” and more “toxic” with each round of financing. More specifically, the liquidation preferences and ratchets often provided new investors in the later rounds of PIPOs can greatly affect the allocation of the risks and the ownership shares and, in so doing, transfer significant wealth from the entrepreneurs and other older owners.Using a numerical analysis of a representative term sheet, the authors discuss the process of financial contracting for early‐stage companies, providing examples of how negotiations can go wrong and showing exactly when and where the agreed‐upon conditions start to turn toxic for some of the stakeholders. The article closes with the authors’ assessment of the disincentives for entrepreneurs and early‐stage investors created by this often confusing and dilutive venture capital contracting and funding process.

Despite its clear importance, there is no consensus on the optimal asset allocation strategy for retirement investors of varying age, gender, and risk tolerance. This study analyzes the allocation question by focusing on the downside risks that result from the joint uncertainty over investment returns and life expectancy. Using a new analytical approach, we show that concentrating on the severity of retirement funding shortfalls, rather than just the probability of ruin, markedly increases the sustainability of a retirement portfolio. We demonstrate that for retirement investors attempting to minimize downside risk while sustaining future withdrawals, appropriate equity allocations range between five and 25 percent, levels that are strikingly low compared to those typically found in life-cycle funds. Further, these optimal portfolio constructions appear to vary little with alternative capital market assumptions. We also show that more aggressive investors having substantial bequest motives should still be relatively conservative in their stock allocations. We conclude that the higher equity allocations commonly employed in practice significantly underestimate the risks that these higher-volatility portfolios pose to the sustainability of retirement savings and incomes.

Private initial public offerings (or PIPOs) are investments in privately held companies of hundreds of millions (in some cases, billions) of dollars that have enabled such companies to postpone or avoid the use of traditional IPOs as a source of growth capital. PIPO transactions have proliferated so rapidly since getting their start in 2012 that, in some industries, they are now more common and raise more capital than IPOs. PIPO funding rounds are also driving the valuations of these private companies to levels previously seen only in the public market.In fact, on almost a weekly basis PIPOs have been creating unicorns-that is, private companies, including Uber and Airbnb, with market valuations greater than $1 billion. And in this review of their study of the economic impact of PIPOs, the authors report having identified 142 unicorns-mostly internet-or other technology-based firms-with a combined value of $625 billion (as of August 2015) and headquarters in 16 countries.The implications of PIPO financing transactions may be significant and long lasting. By remaining private longer, the companies using these large-scale funding rounds may be able to avoid many of the well-documented organizational and governance challenges facing public companies. The ability to operate under private ownership longer may allow PIPO firms to develop their business models more quickly and effectively, capture market share, and enhance their valuations. PIPOs also permit private investors to capture a much greater proportion of the value increases in these companies, which could limit the ability of public market investors to acquire ownership interests in the most promising emerging firms.

One of the biggest risks to a successful retirement is the exposure of savings to poor investment returns in the early stages of the retirement. Mitigating this “sequence-of-returns” risk is in consequence an important investment question. In this study, we conduct extensive simulation analysis to show that for sustainable withdrawal rates, hedging with costless collars or with put options can eliminate or significantly reduce funding shortfall risk for a retirement portfolio. In addition, we demonstrate with a few examples that, for a given level of shortfall risk, hedging can increase the income generated by retirement savings by almost 40%. Thus, downside hedging strategies within retirement portfolios appear to offer attractive benefits to retirees worried about outliving their income resources. TOPICS:Retirement, options, simulations

Using data for more than 800 college and university endowment funds over 2003-2011, we provide a comprehensive analysis of the spending policies used in practice as well as how frequently and why those mandates are revised over time. Given the long-term and relatively static nature of the investment problem faced by the typical educational institution, existing theoretical models of endowment management predict that the permanent portion of the stated spending policy should be highly stable. However, we find that half of the endowments revised their rules at least once and, on average, about a quarter of the sample changed their spending policies each year, implying a retention rate far lower than expected. We show that larger endowments with lower historical portfolio returns and lower past payout levels are more likely to alter their future spending formulas, but that institutions having the ability to invoke special appropriations on a temporary basis are less likely to make adjustments to their permanent rules. Further, we document that both spending rule changes and asset allocation adjustments persist over time and that, consistent with hypothesized behavior, the former tends to lead the latter. Finally, while there is some evidence that endowment funds as a group produce superior returns relative to their policy benchmarks, we show that there is no difference in benchmark-adjusted performance between institutions that either did or did not change their spending rules.

We investigate the quality of the investment choices that sponsors of defined contribution plans offer to plan participants for their retirement portfolios.Using a unique database of over 30,000 plans, we calculate the performance of equity-oriented investment options that were included in plans compared to a sample of funds that were not.On average, plan options produce annualised risk-adjusted returns exceeding those of non-plan options by as much as 120 basis points, an outcome that is relatively insensitive to factor model specifications, time period, or investment style classification.This performance advantage is largely due to actively managed plan options; privately managed institutional funds do not appear to enjoy any incremental performance advantage relative to public mutual funds.We conclude that plan sponsors do appear to possess superior selection skills when designing the set of investment options offered to plan participants.

We use university endowment funds to study the relationship between asset allocation decisions and performance in multiple asset class portfolios. Although endowments differ substantially in asset class composition, policy portfolio returns and volatilities are remarkably similar across the sample. The risk-adjusted performance of the average endowment is negligible, but actively managed funds generate significantly larger alphas than passive ones. This is consistent with endowment managers exploiting their security selection abilities by over-weighting asset classes in which they have superior skills. Contrary to both theory and prevailing beliefs, asset allocation is not related to portfolio returns in the cross-section but does indirectly influence performance.

The investment decision confronting managers of multi-asset class portfolios can be characterized in terms of the passive (i.e., benchmark or policy) and active (i.e., market timing and security selection) strategies they adopt. In this paper, we investigate whether managers select the appropriate combination of active and passive allocations in their portfolios. Noting that this issue is ultimately a risk management question, we adapt a simple framework for establishing what constitutes the optimal level of active and passive risk exposures.We then examine the question empirically using a database consisting of the allocation decisions and investment performance of a large set of university endowment funds over the period from 1989 to 2005. Our findings show that (i) the average endowment had too little active risk exposure in its portfolio, (ii) endowment funds could have significantly increased their risk-adjusted performance by enhancing the scale of the alpha-generating strategies they were already employing, and (iii) this tendency to under-utilize active management skills was more pronounced for larger endowments than for smaller ones. We conclude that the typical endowment fund could have improved its performance by increasing the commitment to its active management skills.

While a mutual fund's investment style influences the returns it generates, little is known about how a manager's execution of the style decision affects portfolio performance. Using both returns- and holdings-based techniques to measure the consistency with which managers approach their investment mandates, we demonstrate that, on average, more style-consistent funds significantly outperform less style-consistent funds on a risk-adjusted basis. This result differs from portfolio turnover and expense ratio effects and is robust with respect to the period used to measure future returns. We also show that fund style consistency and the persistence of risk-adjusted performance over time are distinct influences and demonstrate the potential profitability of trading strategies based on their combined impact. We conclude that deciding to maintain a consistent investment style is an important aspect of the portfolio management process.