Quant Mashup - Alpha Architect Compound Your Knowledge Episode 9: Investor Confidence & Issues with Factor Investing [Alpha Architect]In this week’s post, we discuss two posts. The first post, written by Elisabetta, examines a new method attempting to directly measure aggregate investor overconfidence. The second post, written by Larry Swedroe, examines issues that plague Factor Investing. Factor Investing is Simple, But Not Easy (Video) [Alpha Architect]We are creating a series of long-form educational videos that present materials often covered in our white papers. The intent of these videos is make our content more accessible to visual learners. The video below is a presentation related to a long-form post we have on a post called, “The(...) The Factors that Plague Factor Investing [Alpha Architect]For those interested in the literature on factor-based investing, a new paper by Robert Arnott, Campbell Harvey, Vitali Kalesnik and Juhani Linnainmaa, “Alice’s Adventures in Factorland: Three Blunders That Plague Factor Investing,” focuses on why, in some ways, it has failed to live up to its(...) Aggregate Investor Confidence in the Stock Market [Alpha Architect]What are the Research Questions? A common assumption in finance theory is that agents in the stock market behave rationally. Even if temporary mispricing occurs, due to irrational beliefs or incomplete information of some agents, arbitrageurs swiftly restore equilibria. In contrast, the history of(...) Investment Strategy in an Uncertain World [Alpha Architect]In 1921, University of Chicago Professor Frank Knight wrote the classic book “Risk, Uncertainty, and Profit.” An article from the Library of Economics and Liberty described Knight’s definitions of risk and uncertainty as follows: Risk is present when future events occur with measurable(...) A Remarkable New Factor: The Cash Conversion Cycle [Alpha Architect]The barrier to entry into the factor zoo has increased exponentially. Prof. Harvey (now working with RAFI) made this clear at the 2017 AFA address, when he highlighted the issue with data-mining in front of a room full of academics from top-flight research programs in the country. Prof. Harvey and(...) Compound Your Knowledge Episode 7: Momentum & Short Sellers [Alpha Architect]In today’s video, we examine three articles from last week. The first article, written by Larry Swedroe, examines the Momentum of News. The second article, written by Wes, examines an out-of-sample test on Momentum by looking at Russian stocks in the 19th century. The third article, written by(...) The Momentum of News [Alpha Architect]Since the development of the capital asset pricing model (CAPM) in the 1960s, hundreds of anomalies (what John Cochrane famously called a “zoo of new factors”) have been uncovered in the cross-section of stock returns. While some of the anomalies (such as the size and value factors) have(...) Short Selling + Insider Selling = Bad News [Alpha Architect]What are the research questions? Is there a relationship between short selling activity and insider selling? What is the impact of short selling trading strategies that are conditioned on insider trading signals? Does the price impact of short selling subsume that of insider trading? Is the price(...) Pitfalls When Assessing Market-Timing Strategies [Alpha Architect]Consider a market-timing strategy which supposedly predicts the direction of the stock market trend. Such a strategy generates Buy and Sell signals. A Buy signal is the signal to buy stocks, whereas a Sell signal is the signal to sell. Simple enough, but how does one evaluate the forecast accuracy(...) Why the Size Premium Should Persist w/ @LarrySwedroe [Alpha Architect]As the chief research officer for Buckingham Strategic Wealth and The BAM Alliance, I’m often asked, after any asset class or factor experiences a period of poor performance, if the historical outperformance of stocks with that characteristic has disappeared because the premium has become well(...) 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(...) Reproducible Finance with R: Code Flows and Shiny Apps for Portfolio Analysis [Alpha Architect]R is a programming language that owes it’s lineage to S, a language designed in it’s own developers words, “to turn ideas into software, quickly and faithfully.”(1) Shiny is an “interactive web technology” that makes it easy to take R models and publish them to the web. Jonathan L.(...) Low Volatility Turnover with Value and Momentum [Alpha Architect]What are the research questions? What is the relationship between turnover and returns from a low volatility portfolio that integrates value and momentum exposures with low volatility? Does the relationship change if a only one factor is integrated with a low volatility strategy? Note: This is a(...) Sector Business Cycle Analysis [Alpha Architect]There are different investment approaches to identify sector winners and losers, such as price momentum strategies, top down approach based on specific macroeconomic indicators or bottom-up approaches to identify sectors with improving fundamentals. One widely used approach is business cycle(...) Day of the Week Matters for Some Anomalies [Alpha Architect]According to psychology literature, mood increases from Thursday to Friday and decreases on Monday. In general, people tend to evaluate future prospects more optimistically when they are in a good mood than when they are in a bad mood. In equity markets, the presence of optimism or pessimism that is(...) Rebalancing...Not so Fast [Alpha Architect]My last article used Warren Buffett’s pre-crisis sale of put options to highlight the risk of getting over our financial skis. In both temperament and negotiation, Warren can outlast most bear markets. Many of us cannot. Proponents of rebalancing should acknowledge the real risk that downturns can(...) Low Volatility Can Be Low Turnover [Alpha Architect]Low volatility strategies have garnered a fair amount of popularity and a growing body of supporting research. Studies have shown risk reduction levels of 25%, while turnover has varied from 20% to 120%. However, higher turnover produces higher costs of trading, such that the excess return obtained(...) Trend-Following: A Decade of Underperformance [Alpha Architect]Everyone in finance remembers 2008–the Global Financial Crisis. Yes, I know, the final downward movement in the stock market was in early 2009. However, many remember 2008 as the year of the crisis. So now we are 10 years removed from the crisis. Why do I mention this? After the crisis, some began(...) Is There a Size Effect in the Stock Market? [Alpha Architect]One of the oldest and most persuasive arguments in the stock market is that small stocks outperform large stocks.(1) Warren Buffett, speaking at the 2013 Berkshire Hathaway Annual Meeting, summarized the sentiment when discussing the disadvantages of managing a huge amount of capital: There’s no(...) How Risky are the Value and Size Premiums? Part 2/2 of Volatility Lessons [Alpha Architect]What are the research questions? The main purpose of this study was to examine the changes in the distribution of the US equity risk premium as the return horizon varies over the short term, medium and long term (see here for a piece that covers those topics). In this recap, we look at ancillary(...) The Smart Money Indicator: A New Risk Management Tool [Alpha Architect]We have all heard the mantra, “You can’t time the market!” But in reality, investors attempt to do just that every day as part of their tactical asset allocation strategies, which are less extreme variants of the classic trend-following “risk-on/risk-off” approach, which many associate(...) Manager Sentiment and Stock Returns [Alpha Architect]What are the Research Questions? The authors investigate the asset pricing implications of corporate manager sentiment, focusing on its predictability for future U.S. stock market returns. Specifically, they ask the following research questions: Does high corporate manager sentiment lead to(...) Size and Value in China [Alpha Architect]What are the research questions? China represents the world’s second largest stock market and a growing component of the world’s GDP. China also operates under peculiar political and economic environments relative to the market economies of the Western world. Because China is so unique, a(...) “The Failure of Factor Investing was Predictable” [Alpha Architect]In a recent ETF column, Allan Roth listed five investment lessons. While I agreed with much of what he wrote, one claim—factor investing has “failed miserably”— called for examination of the facts. But first, a little background. William Sharpe, Jack Treynor and John Linter are typically(...) Value, Momentum & Carry Across Asset Classes [Alpha Architect]There is a 72% probability of the San Franciso Bay Area getting hit by at least one earthquake of a magnitude of 6.7 or stronger between today and 2043 according to the United States Geological Survey, which is a scientific agency of the U.S. government. An earthquake of that magnitude is likely to(...) Compound Your Knowledge: Episode 2-ESOPs, Factors, Incentives [Alpha Architect]In today’s video, we examine three posts. First, we examine ESOPs and 1042 QRP (qualified replacement property) with Doug Pugliese. Second, we examine a guest post by Nicolas Rabener examining Value, Momentum and Carry over the past 10 years. Last, we examine a guest post by Elisabetta discussing(...) Rankings and Risk-Taking in the Finance Industry [Alpha Architect]Rankings are everywhere in the finance industry. A number of papers identify bonus schemes and tournament incentives(1) among the main drivers of excessive risk-taking in developed financial markets. The article studies the impact of rankings on professionals’ risk-taking investment decisions.(...) Buyback Blackout Periods Do Not Negatively Impact Market Performance [Alpha Architect]The October 2018 market correction where the S&P 500® Index fell by 7%, its worst October since 2008,(1) left investors searching for a culprit. Some of the usual suspects were blamed — rising geopolitical tensions ahead of the US midterms, the high likelihood of a slowdown in economic and(...) Compound Your Knowledge: Episode 1 [Alpha Architect]Welcome to the newly re-titled weekly video, Compound Your Knowledge. In today’s video, we examine three posts. First, we examine a simple analysis of 2018 Factor portfolio returns. Second, we examine a guest post by Jon Seed examining Warren’s put options, and how they are different than most(...) Quarterly Analysis and Commentary: Q4 2018 [Alpha Architect]We’ve posted our quarterly attribution materials on our performance site.(1) We enjoyed putting the materials together and think they will be informative for those who follow our Indexes. The materials and videos are part of our long-term plan is to continually improve our quarterly communications(...) Equity investing is Riskier than You Probably Expected [Alpha Architect]The purpose of this study was to examine the changes in the distribution of the US equity risk premium as the return horizon varies from monthly, annually, 3 year, 5 year, 10 year, 20 and 30 year periods. The equity premium was calculated as the monthly difference between the Market and Treasury(...) Payday Anomaly Revisited [Alpha Architect]Unless you are a die-hard buy-and-hold investor, chances are that you need to rebalance your portfolio at some point. The question is when? And how often? And why at a specific time? Some strategies rebalance once a year, some multiple times a day. What if there were better times to rebalance? Last(...) Herding and Mutual Fund Performance [Alpha Architect]What are the Research Questions? Can investors identify skilled and unskilled mutual fund managers by observing their tendency to herd? Do differences in herding behavior across funds predict mutual fund performance? Does skill drives the link between herding and future performance? Does herding(...) A Simple Analysis of 2018 U.S. Factor Returns [Alpha Architect]As the year turns, a common practice is to assess a portfolio and see how each position performed. The summary for stocks is easy: equities did not do well. Whether you were invested in U.S. stocks (down ~5%+), developed markets (down ~13%+), or emerging markets (down ~20%+), being invested in(...) Is Active Alpha Enough to Cover Taxes? [Alpha Architect]Each time S&P Dow Jones Indices publishes its latest Active Versus Passive Scorecard, the persistent failure of the vast majority of actively managed funds to outperform is highlighted. The evidence on this failure led Charles Ellis to call active management the loser’s game — while it’s(...) Machine Learning Classification Methods and Factor Investing [Alpha Architect]In the last post in our machine learning series, we showed how nonlinear regression algos might improve regression forecasting relative to plain vanilla linear regression (i.e., when underlying reality is nonlinear with complex interactions). In this piece, we’ll first review machine learning for(...) Data Science is Revolutionizing Investment Practice [Alpha Architect]What are the Research Questions? This editorial introduces data science to the wider investment community and highlights some of the advantages (and potential pitfalls as discussed yesterday) it can bring to everyday investment practice. The paper answers two apparently simple questions: What is(...) A Protocol to Prevent "Quants Gone Wild" [Alpha Architect]What are the Research Questions? Data mining in finance has long been a concern for academic researchers. Campbell Harvey, one of the authors on this paper, is leading the effort to ensure the integrity of empirical finance research. For example, see here for a post on his address to the AFA. The(...) Weekly Recap: Value Performance & ETFs' impact on correlations & liquidity [Alpha Architect]This week Ryan and I discuss two posts. First, we examine a guest post by Matthew Bartolini of State Street Global Advisors, discussing the underperformance of Value and its outlook for 2019. Second, we examine a guest post by Elisabetta on a recent JPM paper examining the effects that ETFs have had(...) After a Lost Decade, Will Value Get its Groove back in 2019? [Alpha Architect]Borne in academia and raised by fund managers seeking to outperform, value style mutual funds and ETFs today hold close to $2 trillion(1). But with poor returns over the past decade, the question of whether “value is dead” has become a popular topic of conversation.(2) The search term “is(...) ETFs Have NOT Screwed Up Correlations, Liquidity, and Alpha Opportunities [Alpha Architect]What are the Research Questions? The paper investigates the following research question: Have ETFs flows affected the correlation structure of returns? Have ETFs flows affected the liquidity of underlying securities? Have ETFs flows affected the ability of managers to generate alpha? What are the(...) Trend Following on Steroids [Alpha Architect]Trend following is well-known and the simplest version is as follows: you buy an asset when it has positive momentum (the price goes up) and you sell it and go to cash (or any other safe haven) when the momentum turns negative.(1) The best-known example of trend following is on the monthly ETF SPY(...) Weekly Recap: Trend-Following, Portfolios, and Risk Factors [Alpha Architect]You can watch the video via the link below: This week Ryan and I discuss three posts. First, we examine a guest post titled, “Trend Following on Steroids,” which examines ways to enhance a simple trend-following strategy. Second, we examine a post I wrote regarding how to use trend-following(...) How to Use Trend Following within a Portfolio [Alpha Architect]A question we have been receiving recently is the following: How should I use trend following within a portfolio? Generally, the questions are related to our Global Value, Momentum, and Trend Index, which allocates to the (1) Value, (2) Momentum, and (3) Trend factors. A big difference between the(...) Measuring Factor Exposures: Uses and Abuses [Alpha Architect]What are the research questions? USES: Can investors really separate “alpha” from “beta”? What are the ins-and-outs of understanding the exposures in a portfolio and their contribution to “alpha”? ABUSES: Are there differences in the way strategies are constructed in academic articles(...) A Proxy for the Unobservable Global Market Portfolio [Alpha Architect]What are the Research Questions? The authors propose an estimation of the capital stock that involves all identifiable and measurable financial and nonfinancial assets in the world economy. This portfolio seeks to represent the so-called “Global Market Portfolio,” that all MBA students learn to(...) Short volatility strategies are extensive and widespread [Alpha Architect]Who are the buyers and sellers of volatility-contingent strategies? How extensive is volatility trading and put selling currently? Could a volatility “cascade” cause a crash across correlated asset classes? Are there mechanisms that might provide stabilization? What are the Academic Insights?(...) Weekly Recap: Factors, Opportunity Zones, and HFs [Alpha Architect]This week Ryan and I discuss three topics. First, we examine the returns to U.S. stock broken down by (1) size and (2) factors (mega-cap stocks were the place to invest over the last 5 years!). Second, we examine a post by Adam Tkaczuk on Opportunity Zones–a must read for those with low basis(...) Factor Investing Fact Check: Are Value and Momentum Dead? [Alpha Architect]The “stock market,” at least as measured via the S&P 500, has been on an epic performance run — especially relative to almost all asset classes. It doesn’t matter whether you look at the other asset classes by geography (e.g., US, developed, emerging), style (e.g., value, momentum), or(...)