The third quarter 2021 issue starts with the fourth in the series of articles celebrating the Journal’s 75 years: “The Financial System Red in Tooth and Claw: 75 Years of Co-Evolving Markets and Technology." In this article, Andrew Lo reflects on the adaption or evolution of financial practice with that of technology. He defines eight eras of financial evolution from 1945 to present, mapping each against the technological development of the era as well as financial and regulatory milestones.

Back to more recent history: The market crash of short volatility strategies on 5 February 2018 was nicknamed “Volmageddon.” This event saw the demise of some inverse VIX exchange-traded products in the US but also holds lessons for us today. In “Volmageddon and the Failure of Short Volatility Products,” Augustin, Chen, and Van den Bergen take us through the steps of the negative feedback loop that created Volmageddon. Through detailed analysis of this case, they demonstrate the pitfalls of hedge and leverage rebalancing when markets are concentrated and volatility spikes. Investors, regulators, and risk managers will all find something to add to their practice as a result of what we learn from that day and this article. In case you missed it, the article "Levered and Inverse Exchange-Traded Products: Blessing or Curse,” makes for a good companion read.

Next, we cover another financial product, namely American Depository Receipts, or ADRs. ADRs allow US investors to participate in foreign equity on the US markets and enable foreign companies to achieve a sort of cross-listing which potentially lowers their cost of capital. For firms in markets such as China where IPO legislation can be tricky, ADRs can be an attractive alternative but these have not been without controversy. Bessembinder, Chen, Choi, and Wei put this all into perspective by analyzing the overall performance of “Chinese and Global ADRs.” They review the performance of ADRs of firms across the world from the 1950s to present. If you’re new to these products, this article will give you an excellent introduction to their breadth, history, and diversity. Investors have enjoyed significant performance benefit and diversification through this market, particularly with respect to Chinese firms — the authors express concern that legislation such as the “Holding Foreign Companies Accountable Act” could be prohibitive to the future of Chinese ADRs in particular.

Speaking of legislation, it’s been more than three years since MiFID II became applicable in Europe and some re-bundling legislation will take effect next year. Soft commissions, or the bundling of execution and research, has been debated and legislated for years. In “To Bundle or Not to Bundle? A Review of Soft Commissions and Research Unbundling,” Bender, Clapham, Gomber, and Koch systematically review all the literature to this point to inform the road ahead for both researchers and legislators. The authors report a consensus in the literature so far about agency conflicts and the costs of bundling. Research post-MiFID legislation in Europe, collectively points to higher research quality but reduced research coverage. But the literature also points to the difficulty of cross-border broking, presents conflicting results on the effect of unbundling on smaller firms, and conjectures about mixed models in the future. This is an excellent cheat sheet on all the work done to this point on soft commissions: The consensus and the conflicts are summarized beautifully with recommendations on the road ahead.

In the next article, “Decarbonizing Everything,” authors from Harvard and State Street analyze how the use of different climate risk measures lead to different portfolio carbon outcomes and risk-adjusted returns. This article provides a good explanation of the origin, strengths, and weaknesses of the different types of carbon metrics: scope 1, 2, and 3 emissions, operational emissions, total value chain, and analysts ratings. The authors attempt to construct a “decarbonizing” factor by designing long–short portfolios combining various metrics. Their results are enlightening, particularly along sector or industry lines.

In “Hedge Fund Performance: End of an Era?” authors from the US and Finland demonstrate that hedge fund performance really did turn a corner after 2008. Aggregate performance has declined across funds and even the ability of established models to select hedge funds hasn’t helped investors much. The authors test a number of different theories but land on the fact that post-2008 reforms and central bank interventions were the likely turning point and they advise investors to calibrate their expectations of hedge fund returns downward from here on.

Finally, authors from Robeco have demonstrated in “Predicting Bond Returns: 70 Years of International Evidence,” that government bonds are predictable and therefore well worth the effort for an active manager. They examine bonds in major markets around the world over a much longer period than other studies have used. They demonstrate robust results to very tradeable strategies with all the details for replication to be found in the article. They attribute the premium available for active bond fund management not to market or macro-economic risks, nor to transaction costs or other investment frictions, but rather to market inefficiency.