Quant Mashup - Alpha Architect A Tactical Asset Allocation Researcher You Should Know [Alpha Architect]I’m a huge fan of hard-core academics that produce incredible research, and yet, very few are familiar with their research. I call these folks, “undiscovered gems.” One might ask why undiscovered gems exist. On one hand, if a researcher produces incredible research, they should be widely(...) The January Effect: An Evidence-Based Perspective [Alpha Architect]January is here again and market commentators are already telling stories about the so-called January Effect. Some articles (examples here and here) are saying the effect is an illusion, while others are claiming the effect can help you make some profits (examples here and here). Before we dig into(...) Go Skew Yourself with Managed Futures [Alpha Architect]Skewness is a statistical measure of how returns behave in the tails of a probability distribution. Wikipedia has a more robust definition of skewness with some good visuals here. If an investment (e.g., stocks) has negative skewness this means that the extreme returns are more likely to be negative(...) Using Trend-Following Rules to Enhance Factor Performance [Alpha Architect]After reviewing the 2016 performance of trend-following (-18.15%), its unclear why anyone would mention the word “trend following” in a public forum. But we’ll give it a whirl anyway… The comedian Victor Borge once famously observed, “Santa Claus has the right idea – visit people only(...) Are you Ready to Witness Finance Research on Steroids? [Alpha Architect]The 2017 American Finance Association conference is kicking off later this week in Chicago. If you haven’t been before — check it out. The conference is the biggest meeting of top-tier academic researchers on the planet. You can review all the research being presented at the following link. Some(...) Time Series Momentum, Volatility Scaling, and Crisis Alpha [Alpha Architect]If you couldn’t tell from our recent monster commodity futures post, we’ve been thinking a lot about futures recently. The futures research area is relatively “fresh,” and a lot more exciting than hacking through equity stock selection research where we already understand the basic answer(...) Interest Rates and Value Investing [Alpha Architect]There is still no value in bonds today. Many readers just had a knee-jerk reaction and they’ve determined that I fall into one of two categories: A total idiot A total genius But let’s dig a bit deeper into the claim that bonds lack “value,” even with this quarter’s 85 basis point back-up(...) Is the Low Volatility Anomaly driven by Lottery Demand? [Alpha Architect]A few years ago I wrote a summary on a working paper titled “A Lottery Demand-Based Explanation of the Beta Anomaly.” The paper is still a working paper, and has been updated (unfortunately they took out a neat picture from the original paper!). Here is a link to the new version of the paper,(...) Great Minds Agree to Disagree on the Source of the Value Investing Premium [Alpha Architect]Active investing sounds so easy. But we all know it is extremely difficult. Ask any deep value investor how they have felt over the past few years (although, they are feeling a lot better recently). Certainly, any credible active investor should be able to answer 2 questions: 1) What is the source(...) In Calm Markets Should We Buy "Cheap" Put Protection? [Alpha Architect]Time for a little myth busting. Recently, the Motley Fool posted an article that argued the following: when market volatility is low, protective put options are cheap. From the article: Smart investors know that the time to buy most investments is when most investors aren’t paying attention to(...) An Evidence-Based Low Volatility Investing Discussion [Alpha Architect]Jack and I had the honor of attending the Evidence-Based Investing conference, hosted by the team at Ritholz Wealth Management. Wow. What a great event and a great group of inspiring investors and thinkers. Abe, Meb, John, Mike, and I had the opportunity to chat about systematic investing. Mr.(...) Long-Short Investing Might Shorten Your Investment Lifespan [Alpha Architect]Over the past several decades, academics have identified numerous variables that seem to predict future expected returns. This has led to a proliferation of so-called “factors” identified in the literature, and created what John Cochrane has labeled the “factor zoo.” Now we we have a zoo of(...) Value Investing using Enterprise Multiples - Is the Premium Due to Risk and/or Mispricing? [Alpha Architect]At Alpha Architect, we are big fans of Value investing (and Momentum). In the past, Wes and I examined which valuation measure had the largest spread between Value and Growth firms. The evidence showed (updated results here) that Enterprise Multiples had the largest spread between Value and Growth(...) The Rebalance Bonus for Value and Momentum Porfolios [Alpha Architect]A sophisticated DFA-focused advisor asked us to conduct some research on the following question: Are there additional portfolio diversification benefits to combining concentrated portfolios of value and momentum stocks relative to combining less concentrated portfolios of value and momentum stocks?(...) How to Turn an Engineer into a Quantitative Investor [Alpha Architect]We receive multiple requests from readers looking to break into the finance industry. Quite often the reader is currently working in a traditional engineering job and looking to make a career switch. The question we often hear is “How does an engineer become a quantitative finance geek?” To(...) Reflexivity and the Feedback Effect in Financial Markets [Alpha Architect]Eugene Fama’s Efficient Market Hypothesis argues that because stock prices follow a “random walk,” future price behavior cannot be predicted. In his seminal paper, “Random Walks in Stock Market Prices,” he explains the relationship between prices and fundamentals: If the random-walk theory(...) How to Measure Momentum? [Alpha Architect]Since we’ve released our new book, Quantitative Momentum, we’ve received a handful of basic questions related to momentum–specifically as it relates to stock selection. At this point, the so-called “momentum effect” has occupied academic researchers for several decades. Researchers have(...) What Is The Best "Risk Off" Asset for Trend Followers? [Alpha Architect]So you’re a trend-follower. Great. But here is a question: What do you invest in when your rules suggest “risk off?” Many investors suggest low duration cash or t-bills. Seems reasonable. But is it optimal? Perhaps we should invest in longer duration risk-off assets like 10-yr bonds? We(...) Value Investing Got Crushed During the Internet Bubble - Here's Why... [Alpha Architect]The dot-com bubble of the late 90s was a wild time in the stock market. Internet stocks were trading through the roof, tech IPOs were a practically daily experience, and people quit their jobs to make millions day trading. And why not? Even a day trading chimp could make money in a market that went(...) Want to Learn Way Too Much About Stock Market Factors? Read This Paper [Alpha Architect]During the past few decades, newly discovered stock anomalies have been embarrassing existing factor models, such as the Fama-French 3-factor. As many readers know, each long or short “leg” of these popular long/short factor portfolios is generally constructed by ranking stocks on one specific(...) Quantitative Momentum: A Guide to Momentum-Based Stock Selection [Alpha Architect]The long wait is over. Our newest book–Quantitative Momentum–is finally here. After 2 years of research review, results replication, reverse engineering, internal idea generation, writing, editing, and final publication, we have a final product. We think the book will help fulfill our firm(...) Introducing the Global Earnings Announcement Premium [Alpha Architect]How do stock prices react to earnings announcements? Sometimes prices go up, and sometimes they go down. But here is a potentially more interesting question: What is the average performance across all stocks that have an announcement? The question of whether stocks earn excess returns in(...) Predicting Booms and Busts in Low Volatility Strategies [Alpha Architect]Low volatility funds are some of the best performers in the market these days. As such, they have attracted renewed attention in addition to significant asset flows. (note: a refresher on low volatility investing is here, h.t. Eric Falkenstein). But a question remains — What does the future hold(...) Tactical Asset Allocation: A Practitioner's Defense of Return Predictability [Alpha Architect]The prospect of being able to successfully anticipate and predict future market returns is irresistible to practitioners and academics alike, although success has proven elusive. Many have fallen short while seeking this “holy grail” of investing. For instance, Goyal and Welch (2008) examined(...) How Dumb Money and Smart Money Drive Stock Market Anomalies [Alpha Architect]Stock market anomalies behave in mysterious ways. Over long periods of time they can provide expected outperformance versus passive indexes, but in the short run they can experience bouts of gut-wrenching underperformance (e.g., value and momentum). What accounts for this sporadic performance and(...) Was the Financial Crisis Really a Valuation Crisis? [Alpha Architect]Most people look back at the dot-com bubble and acknowledge valuations were elevated far above historical norms. Investors ignored historically useful fundamentals, such as earnings and book value, and started relying on measures like eyeballs and clicks. Investors really started to believe, “This(...) Value investing is quite possibly the worst idea...EVER [Alpha Architect]We believe deeply in the value philosophy as first described by Ben Graham: view stocks as ownership in a firm; buy with a margin of safety; avoid stories; think independently; and so forth. In fact, I was so intellectually stimulated by value investing I wrote my dissertation on the subject,(...) The Expensive Lesson of Closet Indexing: Avoid Low Active Share and High Expenses [Alpha Architect]The promise of active investing is compelling: the opportunity to earn higher risk-adjusted returns! And paying a fee to an active manager–who is doing something unique–can make sense. And as we know, the only way to beat a benchmark is by being different from the benchmark, as we discuss here.(...) Is momentum investing dead? Or is it just painful? [Alpha Architect]Sometimes even the best evidence-based active investment strategies can create a formidable challenge to investors seeking to exploit them. Case in point — momentum investing. On the one hand, stock-selection momentum strategies (here is a link to more information) can have the potential to(...) When Academics Disagree on Momentum Investing [Alpha Architect]The academic standard for intermediate-term momentum measurement is “12_2 momentum:” simply sort all stocks based on a stock’s total return over the past twelve months, ignoring the last month. (a discussion is here and here) However, a few years ago Robert Novy-Marx wrote a paper titled “Is(...) Time Series Momentum and Volatility Scaling [Alpha Architect]There is a new paper published in the Journal of Financial Markets that digs a bit deeper into the Moskowitz, Ooi, and Pedersen “Time Series Momentum” paper (some background here). ts paper The paper is behind a pay firewall, but luckily there is a 4 part lecture by the authors explaining the(...) March for the Fallen. Come Join the Alpha Architect Team! [Alpha Architect]Looking for a great challenge on a Saturday morning on September 24th? 2016-08-26 14_58_14-March for the Fallen Come join some members of the Alpha Architect team and our tribe of friends/clients when we take part in the “March for the Fallen” on Saturday, September 24, 2016. We’re aiming to(...) Managed Futures: Understanding a Misunderstood Diversification Tool [Alpha Architect]In my two previous blog posts (here and here), I analyze the performance of bonds during really bad months for US stocks (“Crisis Alpha” months), and I analyze the performance of US stocks during really bad months for US bonds. A quick summary of the results from those prior studies: Bonds have(...) Optimizing Mean Variance Optimization [Alpha Architect]In the 1950s, Harry Markowitz proposed a method to identify the optimal trade-off between risk and return for a portfolio. The theory is broadly termed, “Mean-Variance Optimization (MVO).” Sam Wittig, a Drexel graduate I advised and who did some research for Alpha Architect, shared with us his(...) Dealing with Delistings: A Critical Aspect for Stock-Selection Research [Alpha Architect]Eric Crittenden was recently on Meb Faber’s podcast and he tells a compelling story about the perils of survivor bias in backtesting. Eric’s story begins when he is an undergraduate working on a project for a quantitative finance course. The professor asked that the students develop a systematic(...) Surprise! Size, Value and Momentum Anomalies Survive After Trading Costs [Alpha Architect]Anyone who has spent time reading this blog has become familiar with research involving asset pricing anomalies that generate excess returns. In particular, the academic literature has addressed the following: “size,” or a portfolio of small minus big stocks (SMB) (see here for background)(...) Asset Pricing with-and without-garbage [Alpha Architect]If you are into consumption-based asset pricing theory and the associated empirical attempts to reconcile the theory with the data from the realized equity premium, garbage is a fascinating subject. So let’s talk about asset pricing both with–and without–garbage. garbage First the original(...) Taming the Momentum Investing Roller Coaster: Fact or Fiction? [Alpha Architect]Intermediate-Term Price momentum, originally researched by Jegadeesh and Titman in 1993, documented a how recent stock returns tended to continue in the future. Stocks that were past winners (on average) continue to do well, while stocks that were past losers (on average) continue to perform poorly.(...) Can Investors Replicate the Dorsey Wright Focus 5 ETF Strategy? [Alpha Architect]A long-time reader asked that we examine the performance and process associated with the Dorsey Wright Focus Five ETF (ticker: FV). For those who are unfamiliar with the product, FV is a $3B+ sector rotation fund. The fund is designed to provide targeted exposure to five sector- and industry-based(...) Fine Wine is a Fine Addition to Your Investment Portfolio [Alpha Architect]Here we are in August, a great time to drink–and think–about wine. Of course, as a research-focused finance blog, our angle on wine is a bit different than that of Dr. Vino. A summary of the discussion: …we estimate a real financial return to wine investment (net of storage costs) of 4.1%,(...) Evidence-Based Investing Requires Less Religion and More Reason [Alpha Architect]During the 1600s, the Dutch had a large merchant fleet and the port city of Amsterdam was a dominant commercial hub for trade from around the world. Based on the growing influence of the Dutch Republic, in 1602 the Dutch East India Company was founded, and its evolution into the first publicly(...) Stale Performance Chasing: Beware of Horizon Effects [Alpha Architect]Investors talk a big game when describing how they evaluate mutual funds. They say they consider things like the objectives of the fund, its size, and the longevity of its managers. But there’s one factor that looms larger than all the others: Performance. We wrote here about how investors tend to(...) Style Momentum in Australia? [Alpha Architect]Jegadeesh and Titman (1993) popularized a simple idea: "past winners outperform past losers." Post JT, the relative strength, or "momentum anomaly," was forever ingrained in the minds of academic researchers (which is odd, since the idea had been around 50 years prior to JT 1993,(...) The Folly of Stock Market Forecasting [Alpha Architect]The idea that one can predict stock market movements is somewhat insane. The major problem with stock market forecasting is the lack of evidence that it is possible. I am unaware of any market commentator that has been successful–on a consistent basis–at predicting the future direction of the(...) An Alternative Investment Strategy with Value and Momentum [Alpha Architect]Anyone who follows our website should be familiar with the extensive evidence behind our favorite stock selection strategies: Value Investing Momentum Investing The evidence suggests that high-conviction ( We document why high conviction is important for both value and momentum strategies here and(...) Questioning Everything You Knew about Asset Allocation [Alpha Architect]Is a 100% stock allocation crazy? As long as one addresses their needs for liquidity (as to avoid extracting capital from the markets at bad times) and can tolerate the market price volatility, a 100% or near-100% allocation to equities is not as outlandish as one might suspect. Focusing on(...) Backtesting Based on Multiple Signals - Beware of Overfitting [Alpha Architect]One of the dangers of being a quantitative investor is that when you see patterns in historical data you might wrongly assume they will repeat. Put another way, you might believe an effect is driven by a genuine relationship, when in reality the results are spurious and the result of luck. We wrote(...) Stock Market Anomalies and Baseball Cards [Alpha Architect]I still have a Ken Griffey Jr. Rookie Card. To be honest, I don’t even know where the thing is, but I hope it is it worth a ton of money at this point (although I doubt it). So disclaimer up front: I dabbled in baseball card trading back in the day. And for all of you out there who used to trade(...) Digging Deeper into Adaptive Asset Allocation [Alpha Architect]In some ways, investing is simple. After all, we all want the same things. High returns. Low volatility. Small max drawdowns. Unfortunately, it’s very difficult–if not impossible–to have your cake and eat it too. There are always tradeoffs among these desires that have to be managed by(...) Invert, Always Invert: Will Stocks Diversify Bonds in the Future? [Alpha Architect]My last post, “Will bonds deliver crisis alpha in the next crisis?,” created quite a stir on the blogosphere. The underlying assumption of the analysis is that stocks are a core component of a portfolio and bonds are included to diversify the portfolio. The key takeaway from my analysis is that(...)