AGNOSTIC Papers

AgPa #63: Fire the Winners and Hire the Losers

The Folly of Hiring Winners and Firing Losers (2018)
Rob Arnott, Vitali Kalesnik, Lillian Wu
The Journal of Portfolio Management Fall 2018, 45 (1), URL/research affiliates

I am still in my research on manager selection, so apologies to everyone who doesn’t find that too interesting. We already touched the question on what to do with underperforming managers in AgPa #59 and #60. This week’s AGNOSTIC Paper, however, examines this problem somewhat more generally and delivers some really simple (but psychologically hard-to-execute) common-sense conclusions.

  • Current winners tend to be future losers
  • High fees are the most reliable way to underperform
  • Investors should use factor exposures and valuations to evaluate fund managers

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AgPa #62: 10 Questions to Ask Your Fund Manager

The 10 Most Important Questions to Ask in Selecting a Money Manager (1990)
Jack L. Treynor
Financial Analysts Journal 46(3), URL

Continuing with the challenge of asset manager selection, this week’s AGNOSTIC Paper again focuses on the important soft factors of money managers. Jack Treynor, the author of this week’s paper and one of the giants in finance research, presents a short and entertaining checklist “to ensure that the right questions are asked […]”.

  • Does the money manager present his ideas smoothly and without hesitation?
  • Is the money manager clear and confident about his ideas?
  • Do his ideas have common-sense appeal?
  • Are you comfortable with the money manager’s answers?
  • Does the money manager exhibit detailed knowledge of a broad range of companies and industries?
  • Does the money manager react decisively to new developments?
  • Does the money manager have a large asset base?
  • Does the money manager live baronially—with expensive clubs; houses and cars; and travel by the QE II, the Concorde, or the Orient Express?
  • Are his offices impressive?
  • Is the money manager impressively capitalized?

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AgPa #61: Minivans versus Sports Cars

Sensation Seeking and Hedge Funds (2018)
Stephen Brown, Yan Lu, Sugata Ray, Melvyn Teo
The Journal of Finance 73(6), 2871-2914, URL/SSRN

Tell me about the car you drive and I tell you who you are. In the hope of not offending the car enthusiasts too much, this week’s AGNOSTIC Paper relates the performance and characteristics of hedge fund managers to the type of car they drive. As announced in last week’s article, this is a funny example for the important soft factors that investors should consider when selecting an asset manager.

  • Sports car drivers take more risk and deliver lower performance
  • Funds of sports car drivers come with more operational risk
  • Sports-car-driving investors want sports-car-driving fund managers

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AgPa #60: Some Advice for Asset Manager Selection

Manager Selection, Deselection, and Termination (2020)
Mark Anson
The Journal of Portfolio Management Fund Manager Selection 2020, 46(5), 6-16, URL

After examining the end of the asset manager selection process (i.e. firing decisions) in the last post, this week’s AGNOSTIC Paper provides a broader overview. The author touches a lot of issues and provides some general advice how to cope with them in practice…

  • Asset owners seem to be bad in hiring and firing managers
  • How to decide about firing a manager
  • Style Drift, Style Clustering, and Fees
  • The very important difference between Alpha and Beta
  • Momentum and Crowding

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AgPa #59: Why and When Institutional Investors Fire Asset Managers

Forbearance in Institutional Investment Management: Evidence from Survey Data (2023)
Amit Goyal, Ramon Tol, Sunil Wahal
Financial Analysts Journal 79(2), 7-20, URL

As we all know, extracting excess returns from (equity) markets is not so easy. Identifying and monitoring managers who can reliably do that is therefore at least as difficult, if not harder. In particular, deciding whether to continue working with a temporary underperforming manager is often difficult. This week‘s paper examines how institutional reports approach this problem in practice…

  • Institutional investors are more patient than thought
  • Tolerance for underperformance is surprisingly long
  • Sophistication and risk-appetite of investors do matter

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AgPa #58: International Diversification – Doing the Right Thing is Hard Sometimes

International Diversification—Still Not Crazy after All These Years (2023)
Cliff Asness, Antti Ilmanen, Dan Villalon
The Journal of Portfolio Management 49(6), 9-18, URL/AQR

In the last post (AgPa #57), we have already seen that international diversification is a powerful protection against the higher-than-expected risk of losing real wealth with stocks over the long term. By coincide, three of the OGs from AQR Capital Management also just released an article about the Fors and Againsts of international diversification. Unsurprisingly, I picked that one for this week’s AGNOSTIC Paper…

  • For: Not everyone can invest in the best-performing market
  • Against: Everything crashes together
  • For: Historic returns don’t show changes in valuation
  • For: Valuation levels should eventually matter
  • For: International diversification provides opportunities for active investors

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AgPa #57: Stocks for the Long-Run – Riskier Than Thought

Stocks for the long run? Evidence from a broad sample of developed markets (2022)
Aizhan Anarkulova, Scott Cederburg, Michael S. O’Doherty
Journal of Financial Economics 143(1), URL/SSRN

Stocks for the Long-Run – this is not only the title of Jeremy Siegel’s popular book but also a well-established idea among investors. If you can wait long enough and don’t need your money on the way, just put it in a diversified index fund and wait. This week’s AGNOSTIC Paper challenges this simple advice and shows that even over very long periods, the chance of losing money with stocks can be higher than previously thought…

  • History offers some scary events of wealth-destruction
  • The US equity market is not necessarily representative
  • Global diversification helps tremendously

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AgPa #56: The Equity Risk Premium of Small Businesses

Small Business Equity Returns: Empirical Evidence from the Business Credit Card Securitization Market (2023)
Matthias Fleckenstein, Francis A. Longstaff
The Journal of Finance 78(1), URL

In 2020, there were more than 31M small private businesses in the US. Even though the estimated value of those businesses is “just” $12T, the sheer number is astonishing when compared to about 4,000 tradable US stocks (excluding penny stocks). For stocks, we typically use measures like returns, multiples, and volatilities. But given the lack of daily prices, it is difficult to calculate those measures for small private businesses. This week’s AGNOSTIC Paper is an attempt to change that…

  • Small businesses had an equity risk premium of 10.7% and a volatility of 56%
  • Robustness: the model generates plausible results for S&P 500 stocks

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AgPa #55: Backtests in the Age of Machine Learning

A Backtesting Protocol in the Era of Machine Learning (2019)
Rob Arnott, Campbell R. Harvey, Harry Markowitz
The Journal of Financial Data Science Winter 2019, URL/SSRN/PDF

I have already written about the pitfalls of research in asset management and the importance of good research practices for the application of machine learning. This week’s AGNOSTIC Paper takes this idea even further and provides a seven-point protocol for empirical research in finance.

Exhibit 2 of Arnott et al. (2019).

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AgPa #54: Transitory Inflation

How Transitory Is Inflation? (2023)
Rob Arnott, Omid Shakernia
The Journal of Portfolio Management April 2023, URL/Research Affiliates/SSRN

Full disclosure: I am generally skeptic about macro forecasts and I don’t think statements like “We had the same situation in 1980 and therefore things will develop like XYZ.” are much helpful. In economics, two situations are never exactly the same and we humans are very good when it comes to finding patterns in essentially random data. However, given how important the topic over the last years was and still is, I couldn’t resist the temptation. This week’s AGNOSTIC Paper is a little scenario analysis how “transitory” inflation actually was in the past.

  • Transitory inflation would be a historical best-quintile outcome
  • Historically, it took >5 years to get >8% inflation down to 3%

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