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Asset Management, Portfolio Choice, and Asset Allocation

Paper Session

Sunday, Jan. 4, 2026 8:00 AM - 10:00 AM (EST)

Loews Philadelphia Hotel, Commonwealth Hall D
Hosted By: American Finance Association
  • Clemens Sialm, University of Texas at Austin

A Dynamic Model of Private Asset Allocation

Hui Chen
,
Massachusetts Institute of Technology
Giovanni Gambarotta
,
Liberty Mutual Investments
Simon Scheidegger
,
HEC - Lausanne
Yu Xu
,
University of Delaware

Abstract

Using cutting-edge machine learning methods, we build a state-of-the-art dynamic model of private asset allocation with five key features: (1) finite horizon; (2) illiquidity of private investments; (3) time-varying market conditions; (4) serial correlation in (observed or actual) private asset returns; and (5) regulation-induced portfolio constraints. The model identifies three distinct lifecycle stages for a private asset investor. Both the marginal value of liquidity and the relative value of illiquid assets can be highly sensitive to the state of the portfolio and market conditions. The model makes it clear that return smoothing has no impact on the long-run optimal exposure to private assets, while the illiquidity of private investments makes it difficult to exploit any variation in the actual expected returns. Finally, our model offers regulators a tool for precisely quantifying the trade-offs when setting risk-based capital charges.

The Unintended Consequences of Rebalancing

Campbell Harvey
,
Duke University
Michele Mazzoleni
,
Capital Group
Alessandro Melone
,
Ohio State University

Abstract

"Institutional investors engage in trillions of dollars of regular portfolio rebalancing, often based on calendar schedules or deviations from allocation targets. We document that such rebalancing has a market impact and generates predictable price patterns. When stocks are overweight, funds sell stocks and buy bonds, leading to a decrease in equity returns of 17 basis points over the next
day. Our results are robust to controls for momentum, reversals, and macroeconomic information. Importantly, we estimate that current rebalancing practices cost investors about $16 billion annually—or $200 per U.S. household. Moreover, the predictability of these trades enables certain market participants to profit by front-running the orders of large institutional funds. While rebalancing
remains a fundamental tool for investors, our findings highlight the costs associated with prevailing strategies and emphasize the need for innovative approaches to mitigate these costs."

On the Use of Currency Forwards: Evidence from International Equity Mutual Funds

Wei Opie
,
Deakin University
Steven Riddiough
,
University of Toronto

Abstract

Using a novel, hand-collected, data set of currency forward contracts, we study currency management at US international equity mutual funds. Despite prior evidence indicating funds can enhance their investment performance when using currency forwards, most funds are non-users, which we attribute to higher liquidity risk facing those funds. Among user funds, most construct separate long-short “shadow” currency portfolios that generate small average returns, resulting in almost identical investment performance between user and non-user funds. However, further gains from alternative approaches are limited by costly margin requirements which would significantly increase tracking error and result in underperformance relative to the benchmark.

Tilting at Windmills: Biased Benchmarks and the Risk-Taking Response of Mutual Funds

Richard Evans
,
University of Virginia
Hugh Kim
,
Wilfrid Laurier University
Thomas Maurer
,
University of Hong Kong

Abstract

We study how changes in third-party relative performance evaluation (RPE) shape mutual-fund managers’ incentives. We exploit Morningstar’s 2002 shift from a single U.S. equity peer group to size–style categories and its 2016 introduction of ESG Globe ratings to explore if biased benchmarking disadvantaged certain funds and induced risk-taking. Pre-2002, growth funds received lower star ratings and held higher-beta, more volatile portfolios—especially when the value spread was large. Similarly, before the globe rating introduction, ESG funds held higher risk stocks with lower ESG ratings. These higher-risk holding effects disappear after both the 2002 and 2016 Morningstar reclassification events.

Discussant(s)
Mark Westerfield
,
University of Washington
Jonathan Parker
,
Massachusetts Institute of Technology
Amy Huber
,
University of Pennsylvania
Taisiya Sikorskaya
,
University of Chicago
JEL Classifications
  • G1 - General Financial Markets