Stocks

AgPa #80: Forget Factors and Keep it Simple?

Keeping it Simple: The Disappearance of Premia for Standard Non-Market Factors (2023)
Avanidhar Subrahmanyam
SSRN Working Paper, URL

This week’s AGNOSTIC Paper is almost a cheat as it is only 3 pages long. I found the paper in the newsletter of a German journalist and thought it is so unconventional that I have to write about it. The author, Avanidhar Subrahmanyam, is a well-known financial economist at the UCLA School of Management and articulates a very simple statistical critique on factor investing. I believe it is important to seek disconfirming evidence, so I regard it as duty to look at this paper with an open mind.

  • Only two factors are significant over the last 27+ years

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AgPa #79: The Momentum OGs – 30 Years Later

Momentum: Evidence and insights 30 years later (2023)
Narasimhan Jegadeesh, Sheridan Titman
Pacific-Basin Finance Journal, URL/SSRN

Momentum is one of the strongest phenomena in financial markets. Narasimhan Jegadeesh and Sheridan Titman were among the first who documented the factor in the academic literature back in 1993. Now, 30 years later, they wrote a little overview about what happened since then. In this week’s AGNOSTIC Paper, they particularly focus on Asian stock markets and the potential explanations for sustained momentum profits. Having a good idea why someone takes the other side of a winning trade is crucial to really understand a strategy and I think this paper is quite interesting in this respect.

  • Momentum worked internationally and out-of-sample
  • Momentum is most likely not data mining
  • The evidence speaks against risk-based explanations
  • Underreaction and noise traders seem a plausible explanation

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#4: Warren Buffett is not an Index Hugger

Two weeks ago, the Financial Times (FT) Unhedged Newsletter (URL) joined many others to write about Warren Buffett and Berkshire Hathaway (BRK) in the week of its famous annual general meeting in Omaha. The FT also published an outstanding series on the future of Berkshire Hathaway without the now 93 year-old legendary CEO and Chairman (URL).

I stumbled across some statements in the two Unhedged Newsletters “Warren Buffett: The world’s richest index-hugger” (URL) and “Berkshire’s next move” (URL) from May 6 and 7, respectively. I have nothing qualified to say about Buffett’s succession, but I do believe the statement that Warren Buffett is an index hugger deserves some more discussion.

  • Berkshire Hathaway’s returns over the last 21 years
  • Berkshire Hathaway’s “risk” over the last 21 years
  • What is risk?
  • Berkshire Hathaway in good and bad markets
  • Is Warren Buffett an index hugger?

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AgPa #74: Peer-Reviewed Research is Not Helpful to Predict Returns – Really?

Does peer-reviewed theory help predict the cross-section of stock returns? (2023)
Andrew Y. Chen, Alejandro Lopez-Lira, Tom Zimmermann
Working Paper, URL

This week’s AGNOSTIC Paper examines the holy grail of empirical research and systematic investing. Is all the research from those smart academics and practitioners really helpful to predict stock returns? Or are we all victims of data mining? The paper if of course not the first one examining this issue, but the approach is in my opinion quite interesting and the authors derive some thought-provoking implications. Pure data mining matches the results from decades of peer-reviewed research surprisingly well. The practical implications, however, are in my opinion not as clear as the statistical ones.

Putting all of this together, the authors may be right that peer-reviewed research and theory are (statistically) not helpful to predict stock returns. I do believe, however, that theory and rigor research in the sense of understanding what you are attempting to do is helpful for real-world investing.

  • Return predictors decay out-of-sample – with and without theory
  • Data mining generates similar patterns like peer-reviewed research
  • Out-of-sample decays are similar for data mining and peer-reviewed research

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AgPa #69: Rebalancing Luck

Fundamental Indexation: Rebalancing Assumptions and Performance (2010)
David Blitz, Bart van der Grient, Pim van Vliet
The Journal of Index Investing Fall 2010, 1(2), URL/SSRN

This week’s AGNOSTIC Paper is already more than 10 years old, but still carries a very important message. The core idea is very simple. If you design an investment strategy, you must make decisions about rebalancing. There are two aspects to consider. How much and when. This week’s authors examine the when at the example of fundamental indices. They show that choosing arbitrary rebalancing date(s) introduces substantial luck or bad luck to a strategy. Even more important, this luck or bad luck doesn’t seem to cancel out over time and thus permanently affects real-world returns. Fortunately, however, there are ways to make yourself less dependent from rebalancing luck…

  • Different rebalancing dates lead to different outcomes
  • Rebalancing luck (or bad luck) is relevant and persistent
  • There is a solution: stretch rebalancing over the year

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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 #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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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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