Quant Mashup - Alpha Architect Forbidden Knowledge: Long-Only Academic Factors are Also Cool [Alpha Architect]The standard academic approach to factor analysis is through the lens of long-short portfolios (which often confuses practitioners!). For example, a researcher may take the universe of the largest 1,000 stocks and sort them on “value”, as measured via book-to-market. The “value factor”(...) Enterprise Multiples and Equity Country Allocations [Alpha Architect]The use of valuation multiples in selecting equity securities is well established in the literature, and we’ve covered the research on enterprise multiples here (here is a recent JPM on the topic). However, there are relevant questions as to the effectiveness of multiples when applied to national(...) Are Earnings Forecasts of Sell-side Analysts Biased? [Alpha Architect]There is a substantial body of evidence linking various accounting ratios to expected stock returns. One explanation of the links is that they could be explained by the accounting ratios being associated with systematic sources of risk. Alternatively, they could be associated with mispricing that(...) The Investor's Podcast: Factor Investing (Jack) [Alpha Architect]Recently I was invited to talk with Stig and Preston on The Investor’s Podcast. I thank them for the opportunity and enjoyed the conversation! Below are some of the topics we discussed: What is factor investing? Which factors have historically performed the best? Should one use a single factor or(...) Are Value, Carry and Momentum Regime Dependent? [Alpha Architect]Over the past decade academics and practitioners alike have argued that multi-factor portfolios offer significant benefits to investors looking for enhanced and more diversified solutions. Among the papers making this argument is “The Death of Diversification is Greatly Exaggerated”, co-authored(...) The Investment Factor and Expected Returns [Alpha Architect]It is well documented in the literature that over the long term, low-investment firms have outperformed high-investment firms.(1) This finding has led to the investment factor (CMA, or conservative minus aggressive) being incorporated into the leading asset pricing models—the four-factor Q model(...) Investment, Expected Investment, and Expected Stock Returns [Alpha Architect]A new DFA article by Rizova and Saito (2019, “Investment and Expected Stock Returns”) (1) rehashes previous arguments in Fama and French (2006, 2015) on the investment factor. The core arguments are as follows: Valuation theory predicts that expected investment is negatively correlated with(...) Are Early Stage Investors Biased Against Women? [Alpha Architect]Recent studies of startup activity in the U.S. find that only roughly 10–15% of startups are founded by women. There are a number of potential explanations including gender differences in technical training or risk preferences. However, many have also speculated that part of the gender gap may, in(...) Can Anomalies Survive Insider Disagreements [Alpha Architect]Anomalies such as Value and Momentum have been exploited for years, yet the source of these premiums emerged as a major unresolved puzzle. Potential explanations can be grouped into two broad categories: “compensation for risk” or “mispricing”. This paper studies this puzzle by investigating(...) Liquidity might be a better proxy for Size in equity markets [Alpha Architect]The size premium is one of the factors that we have researched and dug into several times on the blog. You can find just a few here, here, and here. This paper though took a fresh look at the size premium and adds a new perspective that we haven’t previously covered. What are the research(...) Core Earnings: New Data and Evidence [Alpha Architect]Researchers love novel datasets–it gives them a new set of information to conduct studies and test theories. That brings us to this paper, titled “Core Earnings: New Data and Evidence” by Ethan Rouen, Eric So, and Charles C.Y. Wang. The paper uses a novel database created by our friends at(...) Superstar Investors [Alpha Architect]Many famous investors are outspoken about their investment philosophies, and carefully apply them to a select number of securities. Who among us hasn’t thought if they could at least capture some of the talents of our favorite investors in a bottle, we too could be super investors? Turns out you(...) The Quality Factor—What Exactly Is It? [Alpha Architect]While the quality factor has been identified in the literature (including papers such as “Buffett’s Alpha,” “Global Return Premiums on Earnings Quality, Value, and Size,” and “The Excess Returns of ‘Quality’ Stocks: A Behavioral Anomaly”), and there are now a number of investment(...) Active Share: Predictor of Future Performance or Urban Legend? [Alpha Architect]The crowning achievement for investors is the ability to identify which of the few active mutual funds will outperform in the future. Despite an overwhelming body of academic research which has demonstrated that past performance doesn’t guarantee future performance and (as the annual SPIVA(...) Crowded trades, asset centrality and predicting equity bubbles [Alpha Architect]What is a crowded trade? What is asset centrality? Does asset centrality predict bubbles? Can it be exploited? What are the Academic Insights? In the normal course of events, investors perceive and act upon changes in fundamentals that will persist indefinitely (or until the next change in(...) Using Firm Characteristics to Enhance Momentum Strategies [Alpha Architect]Research into the momentum factor continues to demonstrate its persistence and pervasiveness, including across factors. Recent papers have focused on trying to identify ways to improve the explanatory power and performance of momentum strategies. Prior research on Momentum The study “Momentum Has(...) An Analysis of “Graham’s Net-Nets: Outdated or Outstanding?” [Alpha Architect]In an earlier post we analyzed the prominent and often-cited study on “net-nets” conducted by Henry R. Oppenheimer from the Financial Analysts Journal (1986). In this post, we analyze the article “Graham’s Net-Nets: Outdated or Outstanding?” by James Montier. The objective of the article(...) A Framework for Creating Model Portfolios [Alpha Architect]Asset allocation is a very important decision for investors. Model portfolios are constructed with an optimized asset allocation process to help meet investor needs and preferences. The authors investigate the following research question: How does one construct a model portfolio? What are the(...) Alternative Investments - A Field Manual [Alpha Architect]It’s not a perfect world out there and often times alternative funds are mischaracterized, misused, and not put through a rigorous enough portfolio construction process. It’s my hope that I can forewarn you of the proverbial landmines and better prepare you to invest (or not invest) in the(...) Short-Duration Stock Anomaly: Risk or Mispricing [Alpha Architect]Some background on Bond duration: Duration measures bond’s price sensitivity to interest rates changes. It’s estimated based on the discounted expectations of the bond future cash flows and expressed in the number of years. The longer the duration, the higher the bond interest rate risk. (read(...) Quality: Independent attributes or a real factor? [Alpha Architect]The authors do a very nice survey on measures of quality found in the academic literature and in commercially available quality indexes. They examine seven quality categories including: profitability, earnings stability, capital structure, growth, accounting quality, payout/dilution and investment.(...) The Short Duration Premium [Alpha Architect]In my June 4, 2019 article “The Re-Death of Value, or Déjà Vu All Over?” I noted that one possible explanation for at least part of the poor performance of value stocks over the past decade has been the sharp fall in both the real interest rate (due to weak global growth) and unexpected(...) The Volatility Effect Revisited [Alpha Architect]One dirty little secret that has been hiding behind the curtains of finance for a long time, is that high-risk stocks do not have higher returns than low-risk stocks. Back in 1975 Haugen and Heins first recognized the low-risk anomaly: Our emperical efforts do not support the conventional hypothesis(...) Factor Investing from Concept to Implementation [Alpha Architect]There is a substantial debate on the topic of factor investing and whether or not the “backtested” excess returns are actually achievable in practice. Much of the research on the topic suggests that practitioners in the field are unable to capture any of the so-called “factor premiums”. For(...) The Failure of Value Investing explained [Alpha Architect]It’s no secret that value has had a bad bout of performance in recent memory. This underperformance has been thoroughly examined by multiple research teams and we’ve done some of our own work on the subject. We’ve also done in-depth rebuttals to “value investing is dead” articles in the(...) Value: Don't Call it a Comeback, it's Been Here for Years [Alpha Architect]Value and Momentum each had back to back extreme returns (five sigma) days on Monday, September 9th and Tuesday, September 10th. The Dow Jones Thematic Market Neutral Value Index (“Value”) started the week up 3.45%, its best day since inception on December 31st, 2001. The Value Index followed(...) March for the Fallen 2019: Detailed Logistics Outline and What to Expect [Alpha Architect]Action Item: Please let us know your trip details so we can support you as much as possible. We are a little over 3 weeks away from March for the Fallen (#MFTF). NOTE: There is a monster training event occurring simultaneously to MFTF this year so be prepared to dodge humvees and watch out for stray(...) An Analysis of “Benjamin Graham’s Net Current Asset Values: A Performance Update” [Alpha Architect]The study examined the performance of securities that were trading at no more than two-thirds of its Net Current Asset Value (“NAV”) during the 1970-82 period in the US Net nets, on a gross basis, more than tripled the returns of the market (as measured by the S&P 500 TR) Net nets, on a net(...) Crisis proof your portfolio: part 2/2 [Alpha Architect]This is part 2 (part one is here) of an excellent article that examines the feasibility and effectiveness of protecting equity portfolios using traditional passive means and more contemporary active strategies. It is jam-packed with information and analysis that is best consumed in two parts;(...) Can We Explain the Low Volatility Anomaly? [Alpha Architect]One of the big problems for the first formal asset pricing model developed by financial economists, the CAPM, was that it predicts a positive relation between risk and return. But empirical studies have found the actual relation to be flat, or even negative. Over the last 50 years, the most(...) Social Media, News Based Sentiment, and Market Timing [Alpha Architect]With a growing availability of filtered (news) and unfiltered (social media) information, the author investigates the following question: Do news or social media contain any information that is of relevance for investment decision making and if so are the two sources are complementary or(...) Crisis Proof Your Portfolio: part 1/2 [Alpha Architect]This is a unique article in that it directly assesses the feasibility and effectiveness of protecting equity portfolios using traditional passive means and more contemporary active strategies. It is jam-packed with information and analysis that is best consumed in two parts; however, a good summary(...) The Variance Risk Premium is Pervasive [Alpha Architect]The variance risk premium (VRP) refers to the fact that, over time, the option-implied volatility has tended to exceed the realized volatility of the same underlying asset. This has created a profit opportunity for volatility sellers—those willing to write volatility insurance options, collect the(...) Do Most Individual Stocks Outperform Cash? No. [Alpha Architect]I’d argue that a typical investor believes the following–In the past and over the long run, stocks outperformed bonds.(1) However, as highlighted here, an academic paper last year shows that the majority of individual U.S. stocks actually lost compared to Treasury Bills (i.e. the return to(...) Betting Against Beta (BAB) Construction [Alpha Architect]One of the more popular equity strategies over the past decade is low volatility investing. Simply put, this is a systematic strategy that invests in stocks with lower volatility, either measured by Beta or standard deviation. Why? Well, the low-beta anomaly is the fact that in the past, academics(...) No Skill? Well, Active Share Won't Save You! [Alpha Architect]What are the research questions? This paper is the first to examine the impact of including an active share target into the mean-variance optimization process of constructing portfolios. They use the Ceria and Stubbs (2006) approach to robust portfolio optimization as methodology. Monte Carlo(...) Can Low Vol Strategies Be Improved [Alpha Architect]My Advisor Perspective article of June 17, 2019 discussed the regime shifting nature of the low volatility anomaly—low volatility stocks have outperformed high volatility stocks, providing both higher returns while experiencing lower volatility. For example, in his 2012 paper, “Enhancing a(...) Compound Your Knowledge Ep 18: Size, Mom, Sell-Offs, & R Code [Alpha Architect]In this week’s post, we discuss four articles. The size, written by the folks at AQR, is titled “Fact, Fiction, and the Size Effect” and is a deep dive into the Size effect–I highly recommend everyone read the underlying paper as well. The second article examines the baseline historical(...) Value Investing & Concentration [Alpha Architect]As many investors have experienced, Value investing has underperformed for some time now. For the period following the Global Financial Crisis, Value investing (in general) has underperformed (1) the market and (2) Growth stocks. So while the past decade has been rough for Value investors, it can be(...) Strategies to Reduce Crash Risk in Stocks [Alpha Architect]Because equities are much riskier than high-quality bonds, the vast majority of the risk of a conventional 60 percent equity/40 percent bond portfolio is equity risk. Here’s the simple math demonstrating the point. Well-diversified equity portfolios have volatility of about 20 percent, and(...) Pathetic Protection via Protective Puts [Alpha Architect]Investors would like to maximize upside participation while mitigating losses. This preference is at the base of the growth of the liquid insurance market in the form of equity index options. The author investigates the following research question: Are protective put options an effective tail hedge?(...) Enhancing the Performance of Momentum Strategies [Alpha Architect]In “Your Complete Guide to Factor-Based Investing,” Andy Berkin and I presented the evidence demonstrating that momentum, both cross-sectional (or relative) momentum and time-series (or absolute, trend following) momentum, not only increases the explanatory power of asset pricing models while(...) Momentum, Quality, and R Code [Alpha Architect]Welcome to the first installment of Reproducible Finance by way of Alpha Architect. For the uninitiated, this series is a bit different than the other stuff on AA – we’ll focus on writing clean, reproducible code, mostly R (but some python too), applied to different ideas from the world of(...) Market Sell-off Analysis: Baseline Historical Facts [Alpha Architect]We often hear that the market is 5% off its highs or that it is down 5% from the high of the year. This alone does not tell us much. The questions I want to answer are as follows: “How often does that 5% loss become a 10% loss? Or worse yet — a 20% loss?” In other words, what are the(...) Fact, Fiction, and the Size Effect [Alpha Architect]The size effect is the phenomenon in which small stocks (i.e., those with lower market capitalizations), on average, outperform large stocks (i.e., those with higher market caps) over time. The size effect was first documented by several academic papers in the early 1980s ( Banz, 1981). However, it(...) Debunking myths about stock buybacks [Alpha Architect]What are the research questions? The authors present 4 MYTHs regarding stock buybacks popular in the financial press. MYTH 1: Companies are self-liquidating using share repurchases at a historically high rate. MYTH 2: Share repurchases have come at the expense of profitable investment. MYTH 3: The(...) Trend Following: The Epitome of No Pain, No Gain [Alpha Architect]One of the recurring themes we see in our research is the concept of “no pain; no gain.” Or as Corey Hoffstein says, “No pain, no premium.” Cliff Asness may put it best when he says that some strategies require that you hold on to them “like grim death.” Bottom line: nothing is easy in(...) Large-Cap Price-to-Book Investing: What is Dead May Never Die [Alpha Architect]In the great book and series Game of Thrones, the inhabitants of the Iron Islands have a saying “What is Dead May Never Die” which is to be replied with “But rises again harder and stronger.” I am reminded of this saying as more and more market commentators and practitioners declare that(...) Factor Investing Research On Steriods [Alpha Architect]What are the research questions? Do the most prominent long/short factors — value, momentum, carry, and defensive — survive out of sample? Can long/short factors be timed? What are the Academic Insights? YES. All of the factors exist out of sample, albeit their magnitudes are generally muted.(1)(...) Value Factor Valuations Over Time: US and Developed [Alpha Architect]We built a simple tool recently to review so-called value spreads over time. (1) This tool maps out the median valuations for the top decile and bottom decile “cheap stock” portfolios (as measured by EBIT/TEV). Why might this be useful? This tool allows one to identify the “valuation” spread(...)