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Responsible investors require data to underpin their stock and sector selections. Regardless of the rating agency, bond ratings for a particular issuer are broadly similar. This is not the case for ESG ratings. Companies with a high score from one rater often receive a middling or low score from another rater. This article examines the extent of, and reasons for, disagreement among the leading suppliers of ESG ratings. The weightings given to each pillar of an ESG rating also vary across agencies. Many asset managers contend that ESG ratings can help investors to select assets with superior financial prospects, and the authors therefore review the investment performance of portfolios and of indexes screened for their ESG credentials. In the authors' opinion, ESG ratings, used in isolation, are unlikely to make a material contribution to portfolio returns.

We investigate whether economic policy uncertainty and the interaction of foreign equity portfolio flow and economic policy uncertainty impact the cost of capital. Using panel data of 20 countries from 2001 to 2018, we find economic policy uncertainty to exert a positive effect on the cost of capital. However, the interaction between foreign equity portfolio flow and economic policy uncertainty has a negative effect on the cost of capital, demonstrating that, the combined effect of foreign equity portfolio flow and economic policy uncertainty has the opposite effect (i.e., reduces the cost of capital). Our results are robust to alternative specifications and endogeneity.

There are many ways to construct a company’s environmental, social, and governance (ESG) score or rating, involving different combinations of financial and nonfinancial inputs. Determining the most influential criteria for firm performance may be overlooked in the rush to “do some ESG.” In this study, the authors deconstruct ESG ratings performance at the E, S, and G pillar levels and use the most common key issues indicators that underlie ESG scores. They find that the time horizon used has an important bearing on the indicators’ significance. In the short term, they find that governance is the dominant pillar because it strongly reflects event risks, such as fraud. In the long term, however, environmental and social indicators became more important because issues such as carbon emissions tended to be more cumulative, presenting erosion risks to long-term performance. The authors also find that a more balanced and industry-specific weighting of E, S, and G issues showed better long-term relevance than the individual pillar indicators alone. TOPICS: Equity portfolio management, ESG investing, pension funds, foundations & endowments, performance measurement, wealth management, risk management Key Findings ▪ Aggregating environmental, social, and governance pillars into a total ESG rating added value in terms of performance and risk. ▪ Governance indicators showed the greatest significance in the short term because they have tended to materialize as event risks that immediately affected stock prices. ▪ However, some E and S indicators have developed slowly but have had long-lasting financial effects (erosion risks).

We investigate the impact of political uncertainty on the relationship between foreign equity portfolio flow and the cost of capital. Using panel data from 40 countries from 2001 to 2016, our results show that the year before a national election is associated with a higher cost of capital. Further analyses show that the relationship between international equity portfolio flow and the cost of capital is sensitive to political uncertainty. In line with the institutional quality channel, we find that checks and balances interact with political uncertainty to reduce the negative effects of political uncertainty on the cost of capital. The results are consistent with the hypothesis that foreign investors strategically reduce their equity portfolio investment to the recipient country before a national election which reduces risk-sharing between domestic and foreign investors.

In this article, the authors propose a risk estimation model that addresses both smoothness and idiosyncratic risk dynamics of narrow private equity portfolio returns. The authors subsequently apply the model to a broad set of private equity return streams with tightly controlled diversification properties. They show that increased model complexity is detrimental to the model’s forecasting power and that idiosyncratic risks increase as one goes between hypothetical investment in a broad (albeit noninvestable) private equity index and a real-life, narrowly diversified portfolio of private equity funds. The authors also find that private equity returns have demonstrated a level of exposure to public equity markets that may be considered surprisingly low and offer a possible qualitative justification for this phenomenon. Finally, the authors incorporate the newly obtained private equity risk model into a general portfolio construction framework and demonstrate how to study the inevitable trade-offs between the costs and benefits of increased portfolio diversification. TOPICS: Portfolio theory, portfolio construction, equity portfolio management Key Findings • By applying a somewhat novel econometric technique to a proprietary dataset, we offer a way to separately estimate systematic and idiosyncratic risks of private equity (PE) programs. Our methodology controls for data overfitting and program concentration. • Observed volatility and equity beta of PE are much lower than that of public equity. We believe this is not an aberration but instead a fundamental consequence of PE being less exposed to the excess volatility of public equity markets. • With the exception of the tumultuous period of the global financial crisis (GFC), risk properties of private equity have been surprisingly persistent; if anything, systematic risks of private equities decreased slightly after the GFC.

This paper examines whether the widely reported phenomena of home and foreign biases (i.e. suboptimal international equity portfolio diversification) hold any ramifications for the development of stock markets. The results, analysed using macro- and micro-level data, support the view that stock markets that are characterised by a higher degree of home bias are associated with lower levels of development. On the other hand, markets where foreign investors show a higher degree of allocation preference, relative to the prescribed benchmark (foreign bias), are found to be more developed. The results, which are robust to the use of shock based identification strategy, indicate that policy measures that promote optimal international equity portfolio diversification could be crucial in developing the depth and breadth of domestic stock markets.

Purpose This conceptual paper aims to explore portfolio replication to resolve post-COVID pandemic private and public debt. This paper stresses the need to be less dependent on a debt-based system and the emergence Islamic equity market. Design/methodology/approach This study analyses different types of risks involved in Islamic and conventional portfolios by using risk measures such as relative beta and comparatively examining the systematic and downside risk exposure of Islamic and conventional portfolios. Data was collected monthly from 2016 to 2022. Findings The findings indicate that the replications of a conventional portfolio into an Islamic portfolio are compatible with the regulatory standard, sharia boundaries and professional practices developed from investment theory. The result shows that Islamic portfolios have lower risk exposure compared with their conventional counterparts in most of the sample years, therefore, become further attractive for debt–equity portfolio swaps and Sharia-compliant investors preferring low-risk preferences. The result confirmed that the Islamic portfolios have a higher return and less risk than conventional portfolios. Research limitations/implications The implications of this research are to provide a road map to the regulators, policymakers, governments and the financial industry on how to rearrange some of the public and private debt. A likely remedy is incorporating Islamic financial instrument principles through the equitisation of public and private debt. Practical implications This research contributes to investors (particularly those who want to avoid riba [usury] based investment) to make more diversified portfolios by considering Islamic portfolios to reduce risk exposure. Originality/value To the best of the authors’ knowledge, this is the first paper to create bivariate debt–equity portfolios swaps composed of Islamic and conventional assets.

The potential source of additional performance because of the simple act of resetting portfolio weights back to the original weights is referred as the rebalancing premium. It is also sometimes known as the volatility pumping effect or diversification bonus because volatility and diversification turn out to be key components of the rebalancing premium. The purpose of this article is to provide a thorough empirical analysis of the volatility pumping effect in equity markets and to examine the conditions under which it can be maximized. The authors’ main contribution to the understanding of the rebalancing premium is an effort to disentangle and separately measure the isolated impact of various components of the total effect. Using the Fama–French–Carhart four-factor model, they find that, after controlling for factor exposures, the average outperformance of the rebalanced strategy with respect to the corresponding buy-and-hold strategy remains substantial at an annualized level above 100 basis points over a 5-year time horizon for stocks in the S&P 500 universe. They also find that size, value, momentum, and volatility are sorting characteristics that have a significant out-of-sample impact on the rebalancing premium. In particular, the selection of small-cap, low book-to-market, past loser, and high-volatility stocks generates a higher out-of-sample rebalancing premium compared to random portfolios for time horizons from 1 year to 5 years. They also show that the initial weighting scheme has a significant impact on the size of the rebalancing premium. Taken together, these results suggest that a substantial rebalancing premium can potentially be harvested in equity markets over reasonably long horizons for suitably selected types of stocks. TOPICS: Performance measurement, portfolio management/multi-asset allocation, portfolio theory, portfolio construction, equity portfolio management Key Findings • After controlling for factor exposures, the rebalanced strategy generates an average annual outperformance of more than 100 basis points with respect to the corresponding buy-and-hold strategy over a 5-year time horizon for the S&P 500 universe. • The selection of small-cap, low book-to-market, past loser, and high-volatility stocks generates a higher out-of-sample rebalancing premium compared to random portfolios for time horizons from 1 year to 5 years. • Serial correlation as a sorting characteristic does not allow maximization of the rebalancing premium out of sample for time horizons greater than 1 year.

Equity prices depend on risk, expected return, and market liquidity. Market liquidity, however, is an elusive variable. Prevailing thinking relates primarily to revealed liquidity (e.g., posted orders). The authors propose the concept of latent liquidity to complement this definition and discuss liquidity in terms of its empirical assessment, dependence on market structure, and effect on asset pricing. Regarding regulatory policy concerning market structure, the objective should be to enhance market quality, which is tantamount to liquidity provision. This should lead to extended economic benefits because one thing is widely agreed on: All financial markets would benefit from being more liquid.

More than three decades ago, Jacobs and Levy introduced the idea of disentangling stock returns across numerous factors. They identified the relationships between individual stock returns and firm characteristics using a cross-sectional analysis and examined the benefits of using the resulting time series of returns to the disentangled factors for return forecasting. Some years later, an alternative factor model proposed by Fama and French made use of time-series factors based on portfolio sorts (examples of these time-series factors include the return differences between small- and big-capitalization stocks and between high- and low-book-to-price stocks). Recently, Fama and French found that the cross-sectional approach using firm characteristics is better able to explain stock returns than the time-series approach based on portfolio sorts. This article compares models that use cross-sectional factors across firm characteristics with models that use time-series factors based on portfolio sorts and discusses the benefits and challenges of the cross-sectional approach for investment management. TOPICS: Factor-based models, statistical methods, security analysis and valuation, equity portfolio management Key Findings ▪ More than three decades ago, the authors pioneered a cross-sectional approach to factor modeling that disentangled the unique contributions of numerous factors to the pricing of individual stocks. ▪ A time-series approach using portfolio sorts has dominated the asset pricing literature, but cross-sectional analysis using firm characteristics has greater explanatory power for stock returns and helps practitioners address one of the most fundamental issues in investment management: understanding and predicting the returns of individual stocks. ▪ The authors revisit disentangling returns using a cross-sectional model, compare factor models using cross-sectional factors with those using time-series factors, and discuss the benefits and challenges of cross-sectional models.