Quant Mashup - Alpha Architect Inflation surges - how long to return to normal? [Alpha Architect]How long will it take for the current level of inflation to subside? If history is any guide, it could take quite a while. Across 198 policy interest rate hikes of at least 1%, a decrease of 1% in inflation took 2 to 4 years (Havranke and Rusnak, 2013). The authors of this research article conduct(...) The Performance of Major Private Equity/LBO Firms [Alpha Architect]Attracted by the glamour and potential for lottery-like returns, global private equity (PE) assets under management reached $4.2 trillion in 2022. PE involves pooling capital to invest in private companies by providing venture capital (VC) to startups or by taking over and restructuring mature firms(...) Organization Capital and the Cross-Section of Expected Returns [Alpha Architect]This paper focuses on “organization capital,” representing intangible assets in a firm’s key employees that is not captured by classic value measures such as book-to-market. The authors propose a structural model to analyze the impact of organizational capital on asset prices and argue that(...) Technology Spillover Impacts Stock Returns [Alpha Architect]The increasing role of intangible assets compared to physical assets in our economy has been accompanied by increased research into their impact on asset prices and returns. Studies such as the 2020 papers “Explaining the Recent Failure of Value Investing,” “Intangible Capital and the Value(...) Dissecting the Idiosyncratic Volatility Puzzle [Alpha Architect]Idiosyncratic volatility (IVOL) is the volatility of a security that cannot be explained by overall market volatility—it is the risk unique to a particular security. IVOL contrasts with systematic risk, which is the risk that affects all securities in a market (such as changes in interest rates or(...) Unmasking Insights through Human-AI Differences in Earnings Conference Q&A [Alpha Architect]This paper acknowledges the pivotal role of earnings calls in disseminating value-relevant information, with particular emphasis on the Q&A segment. However, it confronts the inherent challenge posed by the unstructured nature of language in these calls, complicating quantitative analysis. In(...) Momentum Research: a summary: high quality articles of note [Alpha Architect]The Jegadeesh and Titman (1993) paper on momentum established that an equity trading strategy consisting of buying past winners and selling past losers, reliably produced risk-adjusted excess returns. The Jegadeesh results have been replicated in international markets and across asset classes. As(...) Trend-Following Filters – Part 7 [Alpha Architect]Financial time series that are structured as data sampled at a uniform time interval, e.g., hourly, daily, weekly, or monthly, are called discrete-time time series and referred to, from a digital signal processing (DSP) perspective, as being in the “time domain.” Technical market analysts(...) International Value Stocks Offering "More Bang for the Buck" [Alpha Architect]Over the very long term, while value stocks have been less profitable and have had slower growth in earnings than growth stocks, they have provided higher returns. Among the reasons are that value stocks have traded at substantial valuation discounts compared to growth stocks, and reversion to the(...) ETF Evolution: what does it mean for investors? [Alpha Architect]The first ETFs emerged in 1993 and closely tracked broad-based indexes for a low fee. Since then, the competitive situation in the ETF industry today has differentiated itself by adding a new breed of ETFs that reflected specialization into popular investment themes. When the evolution of the ETF(...) ESG Preferences Negatively Affecting Market Efficiency [Alpha Architect]Environmental, social, and governance (ESG) investing continues to increase in popularity, with many institutional and individual investors incorporating ESG criteria into their investment decision-making process. Three main themes have driven this massive shift of assets: 1) Many investors are(...) Geographic investing: business activity vs. domicile [Alpha Architect]The article explores the limitations of traditional country-level stock market indexes constructed based on issuing firms’ domicile. Additionally, it introduces a new type of national stock market index called the EMindex, which is based on companies’ business activities rather than their(...) R&D stocks - do asset pricing models do them justice? [Alpha Architect]Since the development of the CAPM, which explains about two-thirds of the variation of returns among diversified portfolios, academic research has attempted to find models that increase the explanatory power of the cross-section of stock returns. Models are not like cameras that provide an exact(...) A New Wolf in Town? Pump-and-Dump Manipulation in Cryptocurrency Markets [Alpha Architect]Pump-and-Dump (P&D) schemes to manipulate the prices of cryptocurrencies are unlike the P&D schemes found in the equity market. They produce very large price distortions on the order of 65%, very large trading volumes of 13.5x the average, and generate very large profits to cryptocurrency(...) Momentum turning points and their impact on market cycles [Alpha Architect]The article investigates time-series (TS) momentum strategies and their performance in financial markets based on various speeds or lookback horizons. The study aims to understand the connections between different speeds of TS momentum, unobservable variables like trend, turning points, and noise(...) Stock-bond correlation and its lessons for investors [Alpha Architect]The correlation between stocks and bonds should be a critical component of any asset allocation decision, as it impacts not only the overall risk of a diversified multi-asset class portfolio but also the risk premia one should expect to receive for taking risk in different asset classes. The problem(...) Short Term Signals - can they produce meaningful alpha? [Alpha Architect]Short-term return anomalies are generally dismissed in the academic literature “because they seemingly do not survive after accounting for market frictions.” In this research, short-term “factors” are taken seriously, and the authors argue the standard parameters may not apply to short(...) The Investment Factor: does it impact returns? [Alpha Architect]Over the long term, low-investment firms have outperformed high-investment firms. 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-theory model (market beta, size, investment, and(...) The determinants of inflation [Alpha Architect]The research questions of the article are as follows: How can a Hidden Markov Model be applied to identify regimes of shifting inflation? What are the characteristics and descriptive information of the identified inflation regimes? Which economic variables are the determinants of inflation and how(...) Structured notes: Wall Street fairy tales that should be avoided! [Alpha Architect]As a general rule of thumb, the more complexity that exists in a Wall Street creation, the faster and farther investors should run. —David Swensen, Unconventional Success Structured products are packages of synthetic investment instruments specifically designed to appeal to needs that investors(...) Factor seasonality - an independent risk factor? [Alpha Architect]Factor seasonality always seemed to be an idea that was too close to factor timing to help build factor strategies. Surprisingly, the authors find a substantial factor seasonality effect across global markets, suggesting that the assumption is unwarranted. This is the first study I have encountered(...) Value and Profitability/Quality: Complementary Factors [Alpha Architect]In his 2012 paper “The Other Side of Value: The Gross Profitability Premium,” Robert Novy-Marx demonstrated that profitability, as measured by gross profits-to-assets, had roughly the same power as book-to-market (value factor) in predicting the cross-section of average returns – profitable(...) Investor demand: can it explain returns? [Alpha Architect]The traditional financial theory attributes security returns to market- or factor-based risk, with no role ascribed to other influences. In this research, the authors argue for including investor demand as an additional variable in explaining returns. Can changes in investor demand generate(...) The Low-Beta Anomaly: are its returns justified? [Alpha Architect]The low-beta anomaly for the capital asset pricing model (CAPM)—low-beta stocks outperform high-beta stocks—was first documented more than 50 years ago by Fischer Black, Michael Jensen, and Myron Scholes in their 1972 paper, “The Capital Asset Pricing Model: Some Empirical Tests.” In our(...) Retail attention metrics: do they produce differences in returns? [Alpha Architect]Abstract: We find that by using a novel measure of investor attention, generated from InvestingChannel’s clickstream data on online financial news consumption, we can identify broad groups of stocks which are less efficiently priced and therefore where anomalies such as Value and Momentum are(...) Regression is a tool that can turn you into a fool [Alpha Architect]Running regressions on past returns is a great tool for academic researchers who understand this approach’s nuance, assumptions, pitfalls, and limitations. However, when factor regressions become part of a sales effort and/or are put in the hands of investors/advisors/DIYers, “the tool can(...) Risk of Momentum Crashes: can it be reduced? [Alpha Architect]My August 4, 2022, Alpha Architect article examined the research demonstrating that cross-sectional momentum has provided a premium that has been found to be persistent across time and economic regimes, pervasive around the globe and across sectors and asset classes (stocks, bonds, commodities and(...) Fund Concentration: Does it impact return? [Alpha Architect]This study explores the degree to which fund concentration as measured by high tracking error or active share, affects the magnitude of excess returns and whether or not the likelihood of outperformance or underperformance are distributed similarly. Three methods of analysis were used to examine the(...) Are Sustainable Investors Compensated Adequately? [Alpha Architect]While sustainable investing continues to gain in popularity, economic theory suggests that if a large enough proportion of investors choose to favor companies with high sustainability ratings and avoid those with low sustainability ratings (sin businesses), the favored company’s share prices will(...) And the Winner Is: Examining Alternative Value Metrics [Alpha Architect]Value as an investment strategy has long been popular in both academia and among practitioners and is supported by valuation theory, which provides a framework for identifying the drivers of expected returns: the prices investors pay and the expected future cash flows investors will receive.(...) Performance of Factors: what the research says [Alpha Architect]Since the discovery of the size, value, and momentum effects in the 1980s and 1990s, a plethora of other factors have been identified in the asset pricing literature, which led John Cochrane to coin the phrase “zoo of factors.” It has raised questions and led to research into how many factors(...) BloombergGPT: Where Large Language Models and Finance Meet [Alpha Architect]Developments in the use of Large Language Models (LLM) have successfully demonstrated a set of applications across a number of “domains”, most of which deal with a very wide range of topics. While the experimentation has elicited lively participation from the public, the applications have been(...) Intangible Value: Modernizing the Factor Portfolio [Alpha Architect]Abstract: The “Intangible Value Factor” (IHML) can play an additive role in factor portfolios alongside the established market, size, value, quality, and momentum factors. This Six-Factor Model avoids the problematic “anti-innovation” bias of traditional factor portfolios and can be easily(...) Attenuation of Anomalies: what role do fundamentals play? [Alpha Architect]The article aims to explore the possibility that changes in fundamentals play a role in the attenuation of stock market anomalies, offering an alternative explanation to the prevailing arbitrage-based explanation. Can the changes in fundamentals explain the attenuation of anomalies? Choi, Lewis and(...) Index Replication: avoid the negatives! [Alpha Architect]There are several significant, well-documented benefits of index funds. In addition to outperforming a large majority of actively managed funds, they tend to have low fees, low turnover (resulting in low trading costs and high tax efficiency), broad diversification, high liquidity, and near-zero(...) Long-Only Value Investing: Size Doesn't Matter! [Alpha Architect]Many factor investors are familiar with “small-cap value investing,” which is a reasonable allocation for long-term investors who can tolerate a lot of volatility. Why are there so many small-cap value investors? Small-cap value investors have been told that the value premium is higher, on(...) Industry classification and the role it plays in momentum strategies [Alpha Architect]Momentum strategies have been popular since the original Jagadeesh and Titman article was published in 1993. Variations on the strategies have employed calculating momentum on an individual and industry basis. For instance, in a 1999 study, Moskowitz and Grinblatt produced a positive and significant(...) How do AI exposures impact future stock returns? [Alpha Architect]In this article we examine the research about how artificial intelligence influences stock returns by analyzing a measurement of firm-level AI exposures called Alness. AI Narrative and Stock Mispricing Arka Bandyopadhyay, Dat Mai, Kuntara Pukthuanthong SSRN, Working Paper A recent version of the(...) Negative Screening and the Sin Premium [Alpha Architect]Negative exclusionary screening refers to an investment strategy in which socially controversial firms in particular sectors are excluded from the portfolio. The Global Sustainable Investment Review reports that, in 2020, more than $15 trillion (43% of total sustainable investments) were invested(...) Intangible-Adjusted Profitability Factor [Alpha Architect]The past decade has witnessed a dramatic increase in spending on intangibles (not just research and development and advertising expenditures, but also expenses related to human capital) relative to tangible capital expenditures on plants and equipment. Given the change, it is not surprising that(...) 2023 Democratize Quant Conference Recap and Materials [Alpha Architect]We recently hosted our 6th Annual Democratize Quant Conference (sign up here for updates). This post is a recap of what we learned at the conference and some resources we can make available to the public. The agenda for the 2023 conference is outlined below: Date Time Topic Presenter Notes 5/18(...) Drawdowns and recoveries - what lessons do they hold? [Alpha Architect]This paper helps investors better understand drawdowns and recoveries, in terms of empirical facts, practical implications, and strategies for handling them. It shows the importance of the “interplay” between drawdowns and recoveries (which the authors call “submergence”), which should not(...) Gold as a Safe-Haven Asset [Alpha Architect]Abstract: In times of extreme macroeconomic events, including war, hyperinflation, or significant economic recessions, many investors believe gold investing is a safe haven. Is that belief warranted? Investors have concerns about the increased risks of inflation and a recession, Congress’ ability(...) Reducing the Impact of Negative Momentum Performance [Alpha Architect]Momentum crashes are a blight on the performance of momentum strategies. Although there has been a fair amount of research on the topic, few practical solutions have emerged to mitigate the impact on portfolios. In this study, the authors document the outperformance of momentum stocks, made somewhat(...) Pursuing Factor Premiums at the Industry and Country Level [Alpha Architect]Given the strong empirical evidence demonstrating the persistence, pervasiveness, robustness, and implementability of premiums for the factors of size, value, momentum, and profitability in the cross-section of returns, investors may be tempted to gain exposure to those factors across industries and(...) Retail Investors - naive and biased? [Alpha Architect]A series of events has led to significantly increased interest in stock and options trading by retail investors: The arrival of investing platforms (such as Robinhood) with zero trading commissions and no account minimums. The COVID-19 pandemic, causing many workers to largely remain at home for(...) ETF Trading: What's the best time? [Alpha Architect]The expense ratio aside, the cost of transacting in an ETF depends on the size of the bid/ask spread at any point in time during the trading day. The ETF investor should make evidence-based trading decisions since the bid/ask spread can range from 1 basis point (bp) to several hundred bps. What are(...) The Drivers of Booms and Busts in the Value Premium [Alpha Architect]Over the almost 100 years that we have had data for U.S. stocks, the value premium (the annual average difference in returns, relative to accounting measures, from buying stocks whose market prices are low versus stocks whose market prices are high) has averaged 4.4% per year (when using(...) Democratize Quant 2023 is Live. Sign-up! [Alpha Architect]We will host our 6th annual “Democratize Quant” conference on May 18th via Zoom. The event is 100% free, but we do screen participants to enforce our “no spammers” policy. Request access Conference website Our speaker line-up is excellent, and we look forward to some exciting discussions.(...) Novel explanations for risk-based option momentum [Alpha Architect]Stock momentum trading is popular in practice and extensively investigated in academic studies. The paper finds a new option momentum, extending a recent study by Heston et al. (2022), who show that options also display momentum. Our risk-based option momentum is substantially stronger, has a risk(...)