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The Economist Cites Andrea Buffa’s Research

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Article references Buffa’s work on fund manager contracts and equilibrium asset prices

Buffa, Andrea

BU School of Management Assistant Professor of Finance Andrea Buffa

Assistant Professor of Finance Andrea Buffa is cited in The Economist for his new paper on asset management contracts and equilibrium prices. Co-written with Dimitri Vayanos and Paul Woolley of the London School of Economics, Buffa’s paper sheds light on the “low beta anomaly” in markets that The Economist believes is a result of how investors choose fund managers.

“Most financial assets these days are not held directly by investors but by professional fund managers on their behalf,” the article states. “And that separation may explain a couple of big anomalies that undermine belief in the efficiency of markets.”

One of those anomalies, according to The Economist, is that greater risk demands greater reward. In practice, this old rule of thumb doesn’t hold up: less volatile (low beta) stocks have offered far higher returns than the theory would suggest. Buffa and his coauthors provide reasoning that explains this “low beta anomaly.”

The Economist references their findings:

Investors judge fund managers by how successful they are relative to their peers, and to benchmarks such as the S&P 500 index. They reward “star” managers who have been successful in the past, giving them new funds to manage and taking money away from poor performers. This new money will be invested in the stocks the managers concerned favour, which are highly likely to be those that have recently performed well (that is why the managers are stars). Such shares will therefore continue to rise in price, which helps explain the momentum effect.

But fund managers also need to worry about underperforming the benchmark, since that will cause them to lose clients. The greatest risk is to have an underweight position in a big company that is rapidly rising in price (5% of the portfolio in a stock that is 10% of the index, for example). If such a stock rises (perhaps because of good news such as higher-than-expected profits), the distance from the benchmark grows. So underperforming fund managers will be under pressure to increase their holdings in such stocks, even if they consider them overvalued (this happened during the dotcom boom).

Read the full Economist article here. Buffa’s paper can be found here.


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