Equity

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 #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 #52: Happier Employees, Better Returns?

Employee Satisfaction and Long-Run Stock Returns, 1984–2020 (2022)
Hamid Boustanifar, Young Dae Kang
Financial Analysts Journal 78(3), URL/SSRN

A common sales-pitch of ESG strategies is the idea that those strategies not only do good for the planet and other stakeholders, but also generate higher returns. I am generally skeptic about this, but there are studies showing that certain ESG variables historically indeed predicted higher returns. A prominent example for this is the paper on employee satisfaction by Alex Edmans (2011). This week’s AGNOSTIC Paper is an out-of-sample test of this study with somewhat more thorough testing.

  • “Best Companies” outperformed several benchmarks
  • “Best Companies” outperformed during crises and out-of-sample
  • Quality and Low-Risk factors explain some of the premium on “Best Companies”

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AgPa #51: Short Sellers vs. Firms

Go Down Fighting: Short Sellers vs. Firms (2012)
Owen A. Lamont
The Review of Asset Pricing Studies 2(1), URL

I like controversial and (in my opinion) misunderstood topics and this week’s AGNOSTIC Paper examines the next big one: short selling. The paper is unfortunately already more than 10 years old, but it is still a go-to reference for short selling. Apart from that, the fights between firms and short sellers are also quite entertaining – at least from an outsider’s perspective…

  • Short-seller-fighting firms tend to massively underperform
  • The results are robust after controlling for the major factors

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SA #18: RPV – ‘Pure Value’ Is Indeed More Value Than ‘Value’

RPV: 'Pure Value' Is Indeed More Value Than 'Value'
April 08, 2023

Summary

  • Systematic value investors bet that a diversified portfolio of fundamentally “cheap” stocks should outperform a portfolio of “expensive” stocks over the long term.
  • The Invesco S&P 500 Pure Value ETF tracks the S&P 500 Pure Value Index and was incepted in March 2006.
  • Compared to other “smart-beta” value ETFs, RPV is a more aggressive value-strategy and only invests in the top 20% value stocks of the S&P 500 universe (currently 82 positions).
  • With this methodology and three fundamental valuation ratios as value signals, the investment process underlying RPV incorporates several best-practices from the academic literature on the value-factor.
  • RPV is well positioned in a value-peer group and (in my opinion) a very good instrument for investors seeking concentrated exposure to the value-factor.


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AgPa #48: Investable Machine Learning for Equities

Investable and Interpretable Machine Learning for Equities (2022)
Yimou Li, Zachary Simon, David Turkington
The Journal of Financial Data Science Winter 2022, 4(1), URL

Regular readers of this blog know that machine learning in asset management is one of my favorite topics and I recently found new interesting material. This week’s AGNOSTIC Paper is the first of two studies and examines an important issue with machine learning models in great detail: interpretability…

  • Machine learning models outperform simpler methods
  • Different models learn different investment approaches

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SA #17: IUSV – Transparent Value With Modest Active Risk

IUSV: Transparent Value With Modest Active Risk
March 29, 2023

Summary

  • The general idea behind the value factor is that a diversified portfolio of fundamentally cheap stocks should outperform over the long term.
  • Since January 2017, the iShares Core S&P U.S. Value ETF has tracked the S&P 900 Value Index and provides transparent exposure to the well-researched value premium.
  • S&P uses three well-known fundamental valuation ratios to identify and overweight “cheap” value stocks with respect to the overall market index.
  • Relying on multiple value signals is in line with the research consensus of the literature on the value factor and differentiates IUSV from some competitors.
  • Despite the recent value drawdown, IUSV kept up with a peer group and should be a reasonable instrument for investors who want to have U.S. large-cap value exposure at modest active risk.


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SA #16: IWD – Low Growth Is Not Necessarily Value – Also For Large Caps

IWD: Low Growth Is Not Necessarily Value – Also For Large Caps
March 27, 2023

Summary

  • There are countless methods and nuances of (systematic) value investing, but the general idea remains “cheap beats expensive”. Not always, but on average over the long run.
  • The iShares Russell 1000 Value ETF tracks the Russell 1000 Value Index and offers a simple, transparent, and cheap implementation of the value premium for US large caps.
  • The Russell value process unfortunately equates “low sales growth” with “value” which contradicts with the best practices discussed in the literature on the value factor.
  • Despite decent performance when compared to an investable value peer-group, IWD is therefore not my preferred value implementation.


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