Beating a Dead Horse: Value investing and momentum investing work
At this stage in our lives we’ve essentially memorized the CRSP/Compustat database. Name an anomaly and we can probably tell you the stats on it fairly quickly.
Legitimate anomalies can usually be described via a behavioral finance lens:
- Can we identify poor psychology in the market? (Why do prices get dislocated along the way)
- Can we identify the limits to arbitrage? (Why don’t large pools of capital arbitrage the anomaly away)
There are 2 anomalies that stand out among all other anomalies: Value investing and momentum investing.
But don’t take our word for it, check out one of my favorite papers on the subject of “anomaly chasing:”
…and the Cross-Section of Expected Returns
You can find the entire laundry list of the papers examined here.
The authors argue that published papers suffer from serious data-mining efforts, and therefore, we need to adjust our statistical inference metrics to account for this fact.
We 100% agree with this insight.
And after considering this “high-bar,” there are only 3 anomalies that withstand the test of time: Value, Momentum, and Durable Consumption Goods (DCG). Value and momentum we know and love, whereas, DCG, while interesting, is a questionable strategy based on our internal research. (one can get the data here)
Perhaps more interesting is the fact that 300+ “anomalies” identified in the academic literature, once adjusted for data-mining, don’t pass the gauntlet. You’ll also notice that many of these strategies are wrapped in “smart beta” wrappers in the current marketplace.
- Dividend Yield
Are you buying a backtest? Or are you buying a sustainable alpha process?