DIVERSIFICATION AND PORTFOLIO MANAGEMENTOF MUTUAL FUNDS

Also edited by Greg N. Gregoriou

ADVANCES IN RISK MANAGEMENTASSET ALLOCATION AND INTERNATIONAL INVESTMENTS

PERFORMANCE OF MUTUAL FUNDS

Diversification andPortfolio

Management ofMutual Funds

Edited by

GREG N. GREGORIOU

Selection and editorial matter © Greg. N. Gregoriou 2007Individual chapters © contributors 2007

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Library of Congress Cataloging-in-Publication DataDiversification and portfolio management of mutual funds / edited by Greg N. Gregoriou.

p. cm.Includes bibliographical references and index.

1. Mutual funds. 2. Portfolio management. I. Gregoriou, Greg N., 1956–HG4530.D575 2006332.63�27—dc22 2006043574

10 9 8 7 6 5 4 3 2 116 15 14 13 12 11 10 09 08 07

ISBN 978-1-349-28541-9 ISBN 978-0-230-62650-8 (eBook)DOI 10.1057/9780230626508

Softcover reprint of the hardcover 1st edition 2007 978-0-230-01915-7

To my mother Evangelia and in loving memory of my father Nicholas

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vii

Acknowledgments xii

Notes on the Contributors xiii

Introduction xxiii

1 Diversification into Art Mutual Funds 1Rachel Campbell and Joshua Pullan1.1 Introduction 11.2 Art as an asset 21.3 Art mutual funds 51.4 Art price data qualifications 81.5 Conclusion 15

2 Funds of Funds: Diversification, Selection orExpense Arbitrage? 18Clark L. Maxam, Seow Eng Ong and Craig Wisen2.1 Introduction 182.2 FOF background and data 212.3 The data 282.4 Empirical results 322.5 Conclusion 47

3 Are Investors Home Biased? Evidence from Germany 57Andreas Oehler, Marco Rummer, Thomas Walker andStefan Wendt3.1 Introduction and related work 573.2 Data 623.3 Empirical analysis 653.4 Conclusion 73

Contents

4 International Mutual Fund Efficiency and Monetary Policy Sensitivity 78Giampaolo Gabbi4.1 Introduction 784.2 The efficiency model and estimates 794.3 Monetary policy sensitivity of international indices 844.4 International mutual funds efficiency and

monetary policy 894.5 Conclusion 92

5 Equity Portfolio Construction: A Comparative Analysis 94Raffaele Zenti, Massimiliano Pallotta, Claudio Marsalaand Stefano Ricci5.1 Introduction 945.2 Portfolio construction: the main steps 965.3 Back-testing methodology and datasets features 1095.4 Main results 1125.5 Conclusion 118

6 Improvements and Limitations of the RevisedMorningstar Fund Rating Methodology 121Roman Kräussl6.1 Introduction 1216.2 The new Morningstar fund-rating approach 1236.3 Improvements and limitations 1276.4 Conclusion 133

7 Mutual Fund Flows and Expected Stock Returns in Germany: The Role of the Benchmark and of Expectation Biases 138Wolfgang Breuer and Olaf Stotz7.1 Introduction 1387.2 Portfolio selection and exogenous returns 1417.3 Portfolio selection and endogenous returns 1437.4 Numerical analysis 1457.5 Implications and hypotheses 1517.6 Empirical analysis 1557.7 Conclusion 161

8 Herding Behavior: Evidence from PortugueseMutual Funds 167Júlio Lobão and Ana Paula Serra8.1 Introduction 1678.2 Hypotheses and methodology 170

CONTENTSviii

8.3 Data 1748.4 Results 1778.5 Conclusion 186

9 The “Best of Both Worlds” Fund: Exchange Traded Funds in Australia 198Paul U. Ali9.1 Introduction 1989.2 ETF structure 1999.3 The anti-delegation rule 2029.4 Conclusion 204

10 The Relative Impact of Different Classification Schemeson Mutual Fund Flows 206Alexei P. Goriaev10.1 Introduction 20610.2 Data description 21010.3 Methodology 21310.4 Relationship between flows and performance relative

to the stated objective category 21610.5 Relationship between flows and performance

relative to the stated objective, Morningstar style,and asset class categories 219

10.6 Relationship between flows and ordinal as well ascardinal measures of performance 224

10.7 Category-specific flow spillover effect froma star fund to the other funds in the family 226

10.8 Conclusion 228

11 Exploiting Industry Momentum with Sector Funds:The Case of the European Market 232Radu Burlacu, Patrice Fontaine and Sonia Jimenez-Garces11.1 Introduction 23211.2 Industry-sector mutual funds 23511.3 Sample and descriptive statistics 23611.4 Average returns of momentum portfolios 24011.5 The performance of momentum portfolios 24511.6 Additional investigations 24811.7 Conclusion 252

12 US and Chinese Mutual Fund Regulation 256Mercer Bullard, Guangxi Jia, Jin Meng and Ji Qi12.1 Introduction 25612.2 Background 257

CONTENTS ix

12.3 Fund offerings 25812.4 Fund governance 25912.5 Disclosure requirements 26112.6 Fund fees 26412.7 Distribution compensation 26512.8 Pricing, sales and redemptions 26612.9 Affiliated transactions 26812.10 Money market funds 26912.11 Conclusion 270

13 Some Insights on the Behavior of the Mutual FundIndustry in Spain 272Manuel Moreno and Gonzalo Rubio13.1 Introduction 27213.2 The mutual fund industry in Spain 27613.3 Data 27713.4 Models of performance evaluation 28013.5 Empirical results 28213.6 Conclusion 308

14 On the Supposed Foreign Superiority: The ItalianTax Puzzle 312Roberto Savona14.1 Introduction 31214.2 Economic framework 31314.3 The tax puzzle 31414.4 The database 31514.5 Empirical results 31714.6 Conclusion 324

15 Corporate Governance of Mutual Funds in Pakistan 334Muhammad Akbar Saeed and Nadeem A. Syed15.1 Introduction 33415.2 Importance of corporate governance for mutual funds 33815.3 History of mutual funds in Pakistan 33915.4 Code of corporate governance in Pakistan and

international best practices 34115.5 Conclusion 350

16 Determinants of Pension Funds Underwritingand Implications for Portfolio Management:Evidence from Italy 353Carlo Fiorio and Marco Percoco16.1 Introduction 35316.2 Social security reforms in Italy 357

CONTENTSx

16.3 Empirical evidence on pension funds underwriting 35916.4 Some implications for portfolio management

of pension funds 36616.5 Conclusion 370

17 Managerial Response to Mutual Fund Performance in the Spanish Market: An Agency Approach 373Begoña Torre-Olmo, Carlos López-Gutiérrez and Sergio Sanfilippo Azofra17.1 Introduction 37317.2 Agency problems associated with information

asymmetries between managers and mutualfund investors 374

17.3 Data and methodology 38117.4 Results 38217.5 Conclusion 385

18 Analysis of the Mutual Fund Demand in the Spanish Market 389Begoña Torre-Olmo, Carlos López-Gutiérrez and Sergio Sanfilippo Azofra18.1 Introduction 38918.2 The role of mutual funds in the future of

financial activity 39118.3 The influence of behavioral factors in investor

decisions to choose mutual funds 39418.4 Empirical analysis 39618.5 Conclusion 404

Index 409

CONTENTS xi

xii

I would like to thank Stephen Rutt, Publishing Director, and AlexandraDawe, Assistant Editor at Palgrave Macmillan, for their suggestions, effi-ciency and helpful comments throughout the production process, as well asKeith Povey (with Paul Dennison and Nick Fox) for copy-editing and edi-torial supervision of the highest order. In addition, I would like to thank thenumerous anonymous referees in the US and Europe during the reviewand selection process of the articles proposed for this volume.

Acknowledgments

xiii

The Editor

Greg N. Gregoriou is Associate Professor of Finance and coordinator offaculty research in the School of Business and Economics at the StateUniversity of New York (Plattsburgh). He obtained his PhD (Finance) fromthe University of Quebec at Montreal and is the hedge fund editor for thepeer-reviewed journal Derivatives Use, Trading and Regulation published byPalgrave Macmillan based in the UK. He has authored over 50 articles onhedge funds, and managed futures in various US and UK peer-reviewedpublications, including the Journal of Portfolio Management, the Journal ofFutures Markets, the European Journal of Finance, the Journal of AssetManagement, the European Journal of Operational Research, and Annals ofOperations Research. He has published four books with John Wiley & SonsInc. and four with Elsevier.

The Contributors

Paul U. Ali is an Associate-Professor in the Faculty of Law, University ofMelbourne, Australia. Paul was previously a finance lawyer in Sydney.Paul has published several books and journal articles on finance andinvestment law, including, most recently, Opportunities in Credit Derivativesand Synthetic Securitization (London, 2005) and articles in Derivatives Use,Trading and Regulation, Journal of Alternative Investments, Journal of BankingRegulation and Journal of International Banking Law and Regulation. He is cur-rently co-editing a book on corporate governance.

Sergio Sanfilippo Azofra is Assistant Professor of Finance at theUniversity of Cantabria. He teaches also in some postgraduate courses

Notes on theContributors

in banking and financial markets. After taking his BS in economics, he com-pleted his PhD in finance at the University of Cantabria. He has been a vis-iting researcher at Cass Business School (City University of London). Hehas research interests in banking and corporate finance and he has pub-lished several papers in academic journals and presented several papers atnational and international conferences.

Wolfgang Breuer is a Professor of Finance at the RWTH Aachen University,Germany’s leading Technical University. From October 1995 to February2000 he was a Professor of Finance at the University of Bonn. He earned hisPhD degree in February 1993 and his habilitation degree in July 1995, bothat the University of Cologne. After his diploma in 1989 he worked one yearin Frankfurt as a consultant at McKinsey & Co., Inc., before he continuedhis academic career. He has written about a dozen books, more than 30 arti-cles in books and numerous peer-reviewed journal articles comprising agreat variety of topics in the field of finance. His current research interestsfocus on portfolio management issues and in particular performance eval-uation for mutual funds as well as behavioral corporate finance and inter-national financial management.

Mercer Bullard is an Assistant Professor of Law at the University ofMississippi School of Law and founder and President of Fund Democracy,a nonprofit advocacy group for mutual fund shareholders. As one ofthe nation’s leading advocates for investors, Professor Bullard has submit-ted comment letters, organized rule-making petition drives, litigatedissues, requested hearings on exemptions, drafted and edited legislation,and testified before House, Senate, Department of Labor, and state com-mittees on mutual funds, 529 plans, 401(k) plans and other regulatoryissues. He was named by Investment News in March 2001 as one of the25 most powerful voices in the financial services industry, cited byBusinessWeek for leading the fight for shareholders’ rights, named bya mutual fund trade publication as one of four “Fund Titans” for 2003,and listed by Registered Rep. magazine as one of “Ten to Watch” for 2004.Professor Bullard has also been widely quoted on mutual fund issuesin major newspaper and financial media, been featured in Business Week,Ticker Magazine, Research Magazine, Worth, TheStreet.com, and other pub-lications, and appeared on NBC Nightly News with Tom Brokaw, CBSEvening News, CNBC, CNN, Wall Street Week, the NewsHour withJim Lehrer, and on other broadcasts. Following a clerkship with JudgeWill Garwood on the US Court of Appeals, Fifth Circuit, Professor Bullardpracticed securities law in Washington DC with Wilmer, Cutler and Pickering,and served as an Assistant Chief Counsel with the Securities and ExchangeCommission. He received his BA from Yale, his MA from Georgetown, andhis JD from Virginia.

NOTES ON THE CONTR IBUTORSxiv

Radu Burlacu is Associate Professor of Finance at the University PierreMendés France, Grenoble. His thesis entitled “Issuing Convertible Bonds: ASignal of Firms’ Quality” obtained the prize of the Best Thesis in Finance –2001, awarded by EURONEXT Stock Exchange and the French FinanceAssociation. His research fields are in asset pricing (information asymme-try, rational expectations equilibrium), portfolio management (mutual fundperformance, ethical investment) and investment decisions with hybridsecurities. He has published several articles in these different fields.

Rachel Campbell completed her PhD on risk management in internationalfinancial markets at Erasmus University, Rotterdam, in 2001. She currentlyworks at the University of Maastricht as an Assistant Professor of Finance.Her work has been published in a number of leading journals, includingthe Journal of International Money and Finance, the Journal of Banking andFinance, Financial Analysts Journal, the Journal of Portfolio Management, theJournal of Risk, and Derivatives Weekly. She teaches for Euromoney FinancialTraining on art investment, and works as an independent economic advisorfor the Fine Art Fund in London, and for Fine Art Wealth Management, UK.

Carlo Fiorio holds a PhD in economics from the London School of Economics.He is currently an Assistant Professor (Ricercatore) in the Department ofEconomics at Milan State University. He is also a Research Fellow of Econpub-blica at Bocconi University, a research centre on public sector economics.His research interests are in microeconometrics and the analysis of fiscalpolicy through micro-simulation.

Patrice Fontaine is Professor of Finance at the University Pierre MendésFrance, and formerly President of the French Finance Association. His PhDthesis entitled “Arbitrage Theory and International Pricing Financial Assets”obtained the prize for the Best Thesis in Finance from the French StocksMarkets’ Society. He is the author of several books on international finan-cial markets, arbitrage theory and exchange risk management. He has pub-lished more than 30 articles on issues related to arbitrage pricing theory,financial integration, international portfolio management, asset pricing andfinancial crises.

Giampaolo Gabbi is Professor of Banking and Risk Management at theUniversity of Siena, Italy, and senior teacher at SDA Bocconi Milan, wherehe coordinates several executive courses on financial forecasting, and riskmanagement. He is Head of the financial areas of Masters in Economics ofthe University of Siena. Professor Gabbi holds a PhD in banking and corpo-rate management. He has published many books and articles in referredjournals, including Decision Technologies for Computational Management Science,MTA Journal, Managerial Finance, and the European Journal of Finance.

NOTES ON THE CONTR IBUTORS xv

Alexei P. Goriaev received his BA in mathematical economics in 1997 atMoscow State University and his MA in finance in 1998 at Tilburg University(both cum laude). He earned his PhD in finance in 2002 at Tilburg Universitywith the thesis “On the Behavior of Mutual Fund Investors and Managers”.Since September 2002, Alexei Goriaev has been Assistant Professor inFinance at the New Economic School. His general research interests are infinancial econometrics, and his recent research focuses on dynamic strate-gies and forecasting of future performance of US and Russian mutual fundsas well as risk factors (in particular, political risks) and corporate financialpolicy in emerging markets.

Guangxi Jia is an LLM candidate at the Washington University School ofLaw in St Louis. He is a 1991 graduate of Xiamen University, where heearned a Bachelor of Laws, and a 1997 graduate of Sun Yat-sen University,where he earned an LLM. Mr Jia has been a partner in Hao Li Wen PRCAttorneys in Shanghai and worked as in-house counsel for Coca-Cola (China)and as an attorney in the Guangzhou office of Brand Farrar Buxbaum, LLP,a US law firm based in Los Angeles.

Sonia Jimenez-Garces is Associate Professor of Finance at the InstitutNational Polytechnique de Grenoble. Her PhD thesis, “Asset Pricing in Multi-Asset Markets with Informational Asymmetry: A General EquilibriumFramework”, obtained the prize Best Thesis in Finance – 2005 from the FrenchFinance Association and the Fondation Nationale pour l’Enseignement de laGestion des Entreprises. She has specialized in rational expectations models,and her publications are mainly in the field of asset pricing and portfoliomanagement with asymmetrically informed investors.

Roman Kräussl obtained his Masters in Economics with a specialization infinancial econometrics at the University of Bielefeld, Germany, in 1998. Hecompleted his PhD on the “Role of Credit Rating Agencies in InternationalFinancial Markets” at Johann Wolfgang Goethe-University, Frankfurt/Main,Germany, in 2002. As the Head of Quantitative Research at CognitrendGmbH, he was closely involved with the financial industry. Currently he isAssistant Professor of Finance at Vrije Universiteit Amsterdam and ResearchFellow with the Centre for Financial Studies, Frankfurt/Main.

Júlio Lobão is a doctoral student in Management Sciences at the Universityof Minho. He has an MSc in finance and was an undergraduate in econom-ics at Faculdade de Economia, University of Porto (Portugal). Previously heworked as a financial analyst and Lecturer at the Instituto de EstudosSuperiores Financeiros e Fiscais (Portugal).

Carlos López-Gutiérrez is Assistant Professor of Finance at the Universityof Cantabria. He also teaches in some postgraduate courses in banking and

NOTES ON THE CONTR IBUTORSxvi

financial markets. He holds a PhD in finance and a Bachelor degree and aDiploma in Business. Professor López is author of several papers on corpo-rate financial distress and efficiency of the bankruptcy law, and he hastaken part in several prestigious national and international professionalmeetings presenting this work.

Claudio Marsala is quantitative portfolio manager for Ras Asset Management,and prior to this he spent several years at the risk management departmentof Ras Asset Management, that he joined in 2001. His main focus is on thepractical application of econometric models to portfolio management. Hestudied economics and econometrics in Pisa and holds a Masters in Financefrom CORIPE, University of Turin.

Clark L. Maxam is currently the Director of Research at Braddock FinancialCorporation. As former Director of Research and Portfolio Manager at NewYork Life Asset Management and Professor of Finance at Colorado College,Dr Maxam combines his 21 years of proprietary fixed income, equity andderivatives trading experience with a PhD in finance from the IndianaUniversity Kelley School of Business. At New York Life, he led product devel-opment in both equities and fixed income and managed or co-managed over$1 billion in assets for their $6 billion quantitative strategies group. His marketexperience includes proprietary fixed income and derivative arbitrage andmarket-making as Senior Vice-President at Security Pacific Global Trading andNatWest Capital Markets. He is a past member of both the Chicago Board ofTrade and the Chicago Mercantile Exchange and was Senior Vice-President offinancial futures floor trading and sales from 1988–93. In 1993, Dr Maxam leftChicago to obtain a PhD in finance from Indiana University which he com-pleted in 1996. Dr Maxam now specializes in quantitative financial modelingof domestic and international equity and fixed income markets. As both anacademic trained in the latest techniques in financial modeling and an experi-enced trader and portfolio manager, Dr Maxam brings a unique perspective tothe development and implementation of quantitative techniques that alwaysemphasize practicality and the realities of a dynamic marketplace.

Jin Meng received a Bachelor’s degree of law from Shanghai University ofFinance and Economy in 2004, and has worked as a legal assistant for aChinese information technology company. She is currently an LLM candi-date at Washington University in St Louis.

Manuel Moreno holds a PhD in economics from the Universidad Carlos IIIof Madrid and a BSc in mathematics from the Universidad Complutense ofMadrid. He is currently Assistant Professor of Financial Economics andAccounting at the University of Castilla La-Mancha at Toledo (Spain),Associate Editor of Revista de Economía Financiera and a member of GARP

NOTES ON THE CONTR IBUTORS xvii

(Global Association of Risk Professionals). He has previously held teachingand research positions at the Financial Option Research Centre (WarwickBusiness School), Universidad Carlos III de Madrid, IESE Business Schooland Instituto de Empresa Business School. In the past, he was the Co-Director of the Masters in Finance program at the University Pompeu Fabrain Barcelona (Spain). His research interests focus on finance in continuoustime with a special emphasis on derivatives markets, financial engineeringapplications, pricing of derivatives, empirical analysis of different pricingmodels, portfolio management and term structure models. His research hasbeen published in a number of academic journals including Review of Deriva-tives Research and the Journal of Futures Markets, as well as in professional vol-umes. He has presented his work at different international conferences andhas given invited talks in many academic and non-academic institutions.

Andreas Oehler is Professor of Finance at Bamberg University and has helda Chair in Management, Business Administration and Finance there since1994. He received his MSc (diploma) and his Doctoral degree in economics,business administration and finance from Mannheim University 1985 and1989, and his Habilitation (postdoctoral degree) in economics and financefrom Hagen University 1994. During his academic career he has worked as asenior and managing consultant at Pricewaterhouse and other companies.His major fields of research are empirical, experimental and behavioral finance,risk management, and banking and financial institutions.

Seow Eng Ong is an Associate Professor in the Department of Real Estate,National University of Singapore and his research includes securitized realestate, price discovery and housing finance issues. Seow Eng sits on the edi-torial board of six international real estate journals such as the Journal of RealEstate Finance and Economics and the Journal of Property Research. He was the2002–03 President of the Asian Real Estate Society and is currently President-elect of the International Real Estate Society. He was the recipient of the 2005International Real Estate Society achievement award for outstandingresearch, education and practice at the international level.

Massimiliano Pallotta joined the risk management team of Ras AssetManagement in 1997, working on the quantitative and technological aspectsof the development of the company’s internal model. In June 2004 he joinedthe quantitative portfolio management unit. He studied mathematics in Milanand he has practical experience on the more advanced technological aspectsof the risk management and portfolio management process.

Marco Percoco, PhD, is a Research Fellow in the Department of Economicsat Bocconi University (Milan, Italy) where he teaches several graduatecourses in the field of applied economics. His main research interests are in

NOTES ON THE CONTR IBUTORSxviii

public policy, infrastructure finance and economics and sensitivity analysisof economic models.

Joshua Pullan works in the Corporate Alliances department at Sotheby’s,London. He is currently writing on art investment in Self-Invested PersonalPensions in the United Kingdom. He has a Masters in Arts Business fromSotheby’s Institute of Art, London. Prior to moving to London he graduatedfrom the University of Western Australia with a Bachelor of Laws/Bachelorof Arts with honours. In 2004 he was admitted as a Legal Practitioner in theSupreme Court of New South Wales, Australia.

Ji Qi is an LLM candidate at the Washington University School of Law in StLouis and a 2001 graduate of Nankai University. Mr Qi previously prac-ticed with Sea & Sea Law Firm in Tianjin, where he advised corporateclients and handled contracts, corporate governance and maritime matters.He has also worked for the Wanhuida Intellectual Property agency draftinglegal documents for trademark affairs. Mr Qi previously founded ChinaKnowledge M & T Co., Ltd, for which he produced guidelines and detailedreports on M&A in China, and established a Century 21 real estate fran-chise, for which he provided management consulting and legal services.

Stefano Ricci joined the quantitative portfolio management unit in June 2004at Ras Asset Management after being in the risk management department fora few months. His focus is on the application of non-linear, non-parametricforecasting models. He previously gained experience in a major Italian bankin pricing complex derivatives. He studied economics and econometrics inPavia and holds a Masters in finance from CORIPE, University of Turin.

Gonzalo Rubio is Professor of Economics and Finance at the University ofthe Basque Country (Spain). He holds an MBA from Columbia Universityand a PhD from the University of California at Berkeley. His research inter-ests have been related to theoretical and empirical topics on asset pricing.He holds the research award of the European Finance Association and haspublished articles on leading international journals on asset pricing, deriv-atives, microstructure and corporate finance. He is currently working onthe relationship between the yield curve and consumer confidence, the pre-dicting performance of risk-neutral densities adjusted by habit preferences,and the relationship between expected return and risk on internationallyintegrated markets. He is the editor of the Spanish Review of Financial Economicsand co-author (with José Marín from the University Pompeu Fabra) of thebook Financial Economics.

Marco Rummer is currently finishing his PhD in financial economics at theUniversity of Bamberg, Germany. He holds an MSc in economics and

NOTES ON THE CONTR IBUTORS xix

finance from the University of York, UK, which was funded by the GermanAcademic Exchange Service, and a BA in management from the Georg-Simon-Ohm Fachhochschule Nuremberg, Germany. His major researchinterests include empirical and experimental research on financial marketsand corporate finance.

Muhammad Akbar Saeed is Assistant Professor of Finance in theDepartment of Management Sciences at Bahria University (Karachi Campus).Akbar completed his MBA in finance in 1982 and Postgraduate Diploma incomputer science in 1989 from the Institute of Business Administration (IBA),University of Karachi. Besides a marine engineering certification, Mr. Saeedis also a Diplomaed Associate of the Institute of Bankers, Pakistan, and anAcademic Member, European Corporate Governance Institute, Belgium.Akbar’s investment banking career of 17 years (1983–2000) with the Invest-ment Corporation of Pakistan (ICP) covered underwriting of public offer-ings, project financing, equity research, and culminated in heading ICP’sMutual Funds Department.

Roberto Savona is Assistant Professor of Financial Markets and Institutionsat the University of Brescia, Department of Business Studies, Italy. Hereceived his PhD in finance at the University of Udine, Italy (2002). He alsoteaches at the Master MF of Brescia and collaborates with SDA and Newfinat Bocconi University. His current research interests include mutual funds,hedge funds, performance measurement, and he has presented his worksat EFMA, FMA, also organizing the Euro Working Group of FinancialModelling Conference held in Brescia in May 2005.

Ana Paula Serra is an Assistant Professor in the Faculty of Economics,University of Porto (Portugal), where she teaches undergraduate and graduatecourses in corporate finance, international finance and investments. She holdsa PhD in finance from the London Business School. Her research concentrateson international asset pricing and capital markets, emerging markets and pri-vatization. Previously, she worked at one of the leading Portuguese invest-ment banks, as a research analyst and asset manager.

Olaf Stotz holds a PhD in finance and is Assistant Professor of Finance atRWTH Aachen University, Germany’s leading Technical University. Hisresearch interests include asset management, behavioral finance, empiricalasset pricing, market efficiency and mutual funds. He has written severalpeer-reviewed research articles in the fields of fund management and theequity risk premium and edited a book on asset allocation. Before his aca-demic career he worked for several years in the finance industry for majorfinancial institutions in Germany.

NOTES ON THE CONTR IBUTORSxx

Nadeem A. Syed completed his MBA (personnel and industrial manage-ment) and Doctorate in business administration (general management)from Aquinas University, Philippines in 1997. He possesses over 15 year’scorporate experience with national and multinational companies. He ispresently serving as Associate Professor and Head of the Department, Manage-ment Sciences, at Bahria University, Karachi, Pakistan. He teaches organi-zation behavior and organization development on MBA courses. He is alsothe Coordinator of the Faculty Research Program at Bahria University. Hehas authored a number of international conference papers in the areas ofHRM systems and practices, e-governance, privatization, and general man-agement.

Begoña Torre-Olmo is Professor of Banking and Finance at the Universityof Cantabria, and is Assistant Vice-Chancellor of teaching staff for theUniversity of Cantabria and member of the Board of the Public ProjectFinance Company of Cantabria Regional Government. She is the coordina-tor of doctorate programs with several important Mexican universities. Shehas research interests in the mutual funds industry and corporate financedistress, and has published several papers in academic journals.

Thomas Walker is a native of Germany. He received a PhD in finance and anMBA degree in finance and international business from Washington StateUniversity (WSU) in Pullman, WA, and a BSc in Wirtschaftsinformatik (man-agement information systems) from the Technical University of Darmstadt,Germany. Dr. Walker joined Concordia University in Montreal, Canada, asan Assistant Professor in 2001. Prior to his academic career, he worked forseveral years in the German consulting and industrial sector for such firms asMercedes Benz, Utility Consultants International, Lahmeyer International,Telenet, and KPMG Peat Marwick. His research interests are in IPO under-pricing, securities regulation and litigation, institutional ownership, insidertrading, and aviation finance.

Stefan Wendt is a doctoral student as well as Research and Teaching Assistantin finance at the University of Bamberg, Germany. He studied internationaland European business studies at the University of Bamberg and at theNorwegian School of Management BI, Sandvika, Norway, and graduatedin 2005. His main research interests include corporate governance andempirical finance.

Craig Wisen is an Assistant professor of Finance at the University ofAlaska, Fairbanks School of Management, and is a Chartered FinancialAnalyst. He received his PhD in finance from the Indiana University KelleySchool of Business in 2002. His primary research interests include mutualfund performance evaluation and real estate.

NOTES ON THE CONTR IBUTORS xxi

NOTES ON THE CONTR IBUTORSxxii

Raffaele Zenti has been Risk Manager at Ras Asset Management from 1997to June 2004, working on the development of the internal risk model and onthe definition and application of risk policies to actively managed portfo-lios. Since 2004 he has been a quantitative portfolio manager: he supervisesa department that manages several portfolios using non-subjective models.He studied economics and statistics in Turin and is Lecturer on the Mastersin finance of CORIPE, University of Turin.

Chapter 1 discusses the introduction of a number of art funds in the finan-cial marketplace which has led to a number of interesting issues arising inthe mutual fund industry. From an investment perspective, art funds pro-vide an alternative avenue down which investors can diversify their port-folios. They also offer investors a market with irregularities and inefficiencies,which art funds may be able to exploit to reap highly attractive returns. Justhow interesting an avenue can this be and what benefits exist from invest-ing in art funds, are addressed in this chapter.

Chapter 2 examines the numerous empirical studies that have analysedthe individual or aggregate performance of mutual funds. Relatively littlework has investigated the effect that the additional management layer fundsof mutual funds (FOFs) may have on its risk-adjusted return. The authorscompare the risk-adjusted returns of FOFs to those generated by a randomselection of mutual funds possessing the same investment objective of theFOFs. FOFs perform no better than their respective benchmarks, andexhibit a propensity for economic underperformance. FOFs tend to investin funds with lower than average expense ratios, but their total fees exceedthose of traditional funds by an average of 0.97 percent suggesting thatthey are engaged in expense arbitrage: buying low-cost funds and repack-aging them as a higher expense fund.

Chapter 3 examines how portfolio selection has been in the focus offinancial research for at least thirty years. With hand-collected data con-taining information about the portfolio structure of private and institu-tional investors, this chapter gives a brief literature review and sheds lighton the home bias effect in Germany from 1990 until 2005. Despite a declineof this effect since the early 1990s, German – in particular private –investors still hold a bigger-than-optimal portion of domestic assets (bondsand equities) in their portfolios compared to the world market portfolio.

Introduction

xxiii

INTRODUCT IONxxiv

Chapter 4 develops a model to estimate the efficiency in internationalmutual funds. The author interprets returns and volatility spreads withbenchmarks and constructs a four-diagram plot to calculate two efficiencyratios and correlate them to monetary policy behavior.

Chapter 5 shows how portfolio construction is a complex phase at thecore of any quantitative asset management process. During this phase port-folio managers face topics like use and misuse of constraints, estimation ofcovariances and other parameters, optimization, and the rebalancing fre-quency. The authors compare, from a practical point of view, different waysto construct benchmark-relative portfolios of stocks. They further considervarious alternatives that a practitioner can face and back-test the associatedportfolios, comparing the results.

Chapter 6 observes that households are increasingly using mutual fundsas their main long-term investment vehicles. Today, the number of mutualfunds available exceeds 17,000 in the United States alone. Market partici-pants are therefore in need of valid, unbiased and straightforward infor-mation in order to select mutual funds with the best future prospects. Themost well-known fund rating system is provided by Morningstar Inc. Thischapter reviews the mid-June 2002 revised Morningstar 5-star rating sys-tem, its many attractive features but also its limitations.

Chapter 7 considers theoretically the portfolio selection problem for (pri-vate) mean-variance investors and (professional) tracking-error investorsand examines the optimal wealth delegation from the former group to thelatter (mutual fund flows). Moreover, the authors study empirically theGerman stockmarket and find (among other things) that fund flows impactbenchmark stocks and non-benchmark stocks in different ways. Within theauthors’ model, their observations can be explained by a private investors’mean-reverting expectation bias regarding mutual fund returns.

Chapter 8 tests for herding by Portuguese mutual funds over the period1998–2000 using the herding measure suggested by Lakonishok, Schleifer,Thaler and Vishny (1992). The authors find strong evidence of herdingbehavior for Portuguese mutual funds and the level of herding is four tofive times stronger than the herding found in previous studies.

Chapter 9 investigates the popular types of mutual funds worldwidecalled Exchange Traded Funds (ETFs). In general, they offer lower fees,greater pricing transparency and greater liquidity than other mutual fundsfollowing comparable investment strategies. The chapter discusses thedual trading structure of ETFs and the key legal concerns that arise whendesigning ETFs for a common law market.

Chapter 10 examines the nature of competition for new investor moneyin the mutual fund industry by analysing how fund flows are affected bytheir relative performance within different types of categories. The authordemonstrates that domestic stock and domestic bond funds should outper-form not only their peers with the same stated objective or Morningstar

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style, but also other funds within the same asset class in order to attractinvestors.

Chapter 11 examines the increasing globalization and changing marketconditions, whereby European mutual fund managers turn more and moretowards industry placement. The authors find that momentum strategiesbased on sector funds provide positive risk-adjusted abnormal returnseven after subtracting expenses, loads and redemption fees. Their resultsrepresent a challenge for the efficient markets hypothesis.

Chapter 12 provides a comparative overview of mutual fund regulation inthe USA and China. The chapter compares each country’s approach to keyaspects of the regulation of investment pools, including affiliated transac-tions, corporate governance and sales practices, and offers insights into howChina’s nascent regulatory regime may evolve in light of the US experience.

Chapter 13 analyses the mutual funds industry in Spain. The empiricalevidence reported in this chapter shows striking differences in behavioramong management companies when distinguishing among banks, sav-ings banks and independent management companies. One possible expla-nation may be the universal banking model characterizing the Spanishfinancing system. As a consequence, a worrying lack of competition in theSpanish mutual fund industry can be observed.

Chapter 14 describes the worldwide escalation of the mutual fundsindustry over the last two decades by stimulating major players to offertheir products beyond national borders. In Italy the role of foreign firms hasgrown significantly, since it is widely believed that foreigners outperformItalian money managers in almost all investment categories. With the pur-pose of inspecting this supposed foreign superiority, the author’s empiricalanalyses demonstrate that this common view is due to tax distortionbetween domestic and non-domestic funds.

Chapter 15 examines the best global practices and codes of corporategovernance in the context of mutual funds and then compares them withthe practices and the regulatory regime for the mutual fund industry inPakistan. Historical perspectives of the mutual fund industry in Pakistanare also addressed.

Chapter 16 investigates public spending for pensions, one of the mostrelevant items in government budgets. Public spending on pensions hasbecome a source of concern for policy-makers as, given the PAYGO systemin use in most countries, the ageing of the population as measured by thepercentage of individuals in working age is declining and is expected todecline even more. In recent years Italy has undertaken reforms to movetowards more sustainable pension systems. The data-set used in this chapteris the Survey of Household Income and Wealth (SHIW) published by theBank of Italy and based on interviews in 2002. It is found that the probabilityto underwrite such an instrument is positively correlated with educationand negatively with the age of the worker. The fact that younger workers

are more willing to join pension funds is crucial for portfolio management,as this situation calls for a long-term investment horizon. The presence of lia-bilities (in terms of pensions) occurring in the long run will lead the market todemand new instruments, such as long-term indexed bonds, and for a port-folio composition reflecting the constant relative risk-aversion of workers.

Chapter 17 illustrates the moral hazards in the Spanish market of mutualfunds that determine manager activity in terms of risk-taking behavior,window-dressing, or follow-up of active or passive management strategies.

Chapter 18 attempts to shed some light on the mutual fund industryfrom the standpoint of how participants choose these financial products.The authors analyse which factors are most important to investors and findthat financial factors and behavioral arguments must both be considered.

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