Empirical Facts

AgPa #36: Factor Investing – Fact and Fiction

Fact, Fiction, and Factor Investing (2023)
Michele Aghassi, Cliff Asness, Charles Fattouche, Tobias J. Moskowitz
The Journal of Portfolio Management Quantitative Special Issue 2023, URL

Whenever AQR writes about systematic investing, it’s (in my opinion) time to listen. This one is a very good overview about factor investing. Given that this is the intellectual basis of many things I do here on the website, it perfectly fits to the series.

  • Fiction: Factor investing is just data-mining
  • Fact: Factors are risky
  • Fiction: Factor diversification doesn’t work
  • Fact: Factors work in different market regimes
  • Fiction: Factors don’t work anymore
  • Fact: Factors were and are not crowded
  • Fiction: Everyone should (and can) invest in factors
  • Fact: Factor discipline beats factor timing
  • Fact: Sticking with factors is often difficult

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AgPa #35: Rethinking Active Management

Measuring skill in the mutual fund industry (2015)
Jonathan B. Berk, Jules H. van Binsbergen
Journal of Financial Economics 118(1), 1-20, URL/SSRN

From several of my earlier articles you may (correctly!) gained the impression that I am somewhat skeptical about the value-add of most (not all!) active fund managers. However, an excellent episode of the Rational Reminder Podcast featuring Jonathan Berk and Jules van Binsbergen convinced me of another perspective. This week’s AGNOSTIC Paper summarizes their work…

  • Alpha and outperformance alone do not measure skill
  • The average active manager added value – $3.2M per year
  • Investors identify and reward value-adding active managers
  • Active managers still overcharge – net alphas are negative

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AgPa #32: Agnostic Fundamental Analysis (3/3)

Boosting agnostic fundamental analysis: Using machine learning to identify mispricing in European stock markets (2022)
Matthias X.Hanauer, Marina Kononova, Marc Steffen Rapp
Finance Research Letters 48, URL/SSRN

The third and final post about agnostic fundamental analysis. This week’s AGNOSTIC Paper challenges the simple linear methodology and introduces vastly improved valuation models…

  • More sophisticated valuation models yielded better performance
  • Different models emphasize different fundamental variables

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AgPa #31: Agnostic Fundamental Analysis (2/3)

Global market inefficiencies (2021)
Söhnke M. Bartram, Mark Grinblatt
Journal of Financial Economics 139(1), 234-259, URL/SSRN

The second AGNOSTIC Paper on agnostic fundamental analysis. This one is the international out-of-sample test where the authors apply their methodology to stock markets around the world. The results point in the same direction and suggest robust out-of-sample evidence…

  • Undervalued stocks outperformed overvalued stocks – also globally
  • Agnostic fundamental analysis yielded significant alpha – globally and against up to 80 factors
  • Agnostic fundamental analysis remains profitable after transaction costs
  • The degree of market efficiency differs around the world

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AgPa #30: Agnostic Fundamental Analysis (1/3)

Agnostic fundamental analysis works (2018)
Söhnke M. Bartram, Mark Grinblatt
Journal of Financial Economics 128(1), 125-147, URL/SSRN

This week’s AGNOSTIC Paper tackles a very basic question: Does fundamental analysis work? For that purpose, the authors introduce an agnostic valuation model that explains the market capitalization of companies by their most recent fundamentals. A strategy that bets on the convergence of prices and estimated “fair” values generated strong profits between 1987 and 2012…

  • Undervalued stocks outperformed overvalued stocks by about 0.5% per month
  • Agnostic fundamental analysis yielded significant alpha

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AgPa #25: The Economics of High-Frequency-Trading

The Economics of High-Frequency Trading: Taking Stock (2016)
Albert J. Menkveld
Annual Review of Financial Economics, Vol. 8, 1-24, URL/SSRN

This week’s AGNOSTIC Paper examines once again a somewhat controversial topic: high frequency trading. The (public) image of HFTs is quite mixed with a clear tendency towards negative. However, an open-minded and scientific analysis suggests that we are probably better off with HFTs than without them…

  • Trading costs strongly decreased between 2001 and 2011
  • HFTs are fast, well-informed, and often market makers
  • Order-preying and arm’s races – it’s not all good
  • The benefits seem to outweigh the costs

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AgPa #24: Market Capitalization vs. GDP

The big bang: Stock market capitalization in the long run (2022)
Dmitry Kuvshinov, Kaspar Zimmermann
Journal of Financial Economics 145(2), 527-552, URL

This week’s AGNOSTIC Paper is admittedly not very practical but probably more relevant today than ever before. The authors examine the outstanding performance of equity markets since the end of the inflationary 1970s and early 80s. A regime shift that they call the big bang. There are some surprising results, especially beyond the general debate about steadily falling interest rates…

  • The Big Bang: market capitalization detached from GDP growth after the 1980s
  • Most of the Big Bang comes from higher stock prices
  • Falling interest rates are surprisingly not the main driver
  • Higher profitability of listed firms is much more important

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AgPa #19: ESG Confusion (2/2)

Aggregate Confusion: The Divergence of ESG Ratings (2022)
Florian Berg, Julian F. Kölbel, Roberto Rigobon
Review of Finance, Corrected Proof, 1-30, URL

The second AGNOSTIC Paper on the confusion around ESG. This one examines the disagreement of ESG ratings in much more detail and provide some explanations why they are so different…

  • ESG ratings disagree: the average correlation is just 0.54
  • 709 indicators and 64 categories: no wonder that there is disagreement
  • Most disagreement comes from “measurement” and “scope”
  • There is a “rater effect” for ESG ratings

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AgPa #16: Concentrated Stock Markets (7/7)

Mutual Fund Performance at Long Horizons (2022)
Hendrik Bessembinder, Michael J. Cooper, Feng Zhang
SMU Cox School of Business Research Paper No. 22-11 via SSRN, URL

The seventh and final AGNOSTIC Paper on the extreme concentration in stock markets. This one is an out-of-sample test and documents very similar concentration and positive skewness for US mutual funds between 1991 and 2020.

  • Longer investment-horizons lead to extremer return distributions – also for mutual funds
  • Most active managers underperform passive benchmarks – especially over the long-term
  • Compared to the S&P 500, mutual fund investors lost about $1.3T between 1991 and 2020

But a picture is worth a thousand words…


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AgPa #15: Concentrated Stock Markets (6/7)

Extreme Stock Market Performers, Part I: Expect Some Drawdowns (2020)
Hendrik Bessembinder
SSRN Working Paper, URL

The sixth of seven AGNOSTIC Papers on the extreme concentration in stock markets. This one shows that even for the top wealth-creators, the road to success has been anything but smooth…

  • Even the best companies during their best decades had substantial drawdowns
  • Today’s drawdowns of tomorrow’s winners are even worse

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